japan’s monetary easing policy
Monetary expansionary policy is where the central bank decreases interest rates and increases money supply to the economy.This can be achieved by decreasing the base rate, decreasing the reserve requirement ratio for banks and buying bonds. This article focuses on the ‘multi-billion bond buying scheme’ that is part of the monetary policy initiated by the Japanese Prime Minister Shinzo Abe.
The purchase of government bonds by the central bank increases the money supply in the economy, so that more loans become available. In turn, people are able to borrow money more easily and, ‘a rise in business and public investment, private consumption and industrial production,’ should result. Also because investment and consumption are both components of aggregate demand, this should increase. This will then hopefully increase real output and the rate of inflation, meaning an increase in the average price level. It is plausible that this monetary policy is therefore able to bring, ‘an end to deflation’, where the average price level decreases, for Japan.
The diagram above illustrates that the supply of money increases from MS1 to MS2 because the central bank is buying up bonds, therefore interest rates decrease from R1 to R2 so the amount of money demanded expands from M1 to M2. With lower borrowing costs, in terms of the interest rate, firms are then likely to increase the volume of investment from I1 to I2. Overall an increase in investment means that aggregate demand will increase from AD1 to AD2, which should cause an increase in real output, from Y1 to Y2, and an increase in the average price level, from P1 to P2.
In addition, the increase in money supply has, ‘driven down the value of the yen’. So exports have become more competitive abroad and imports less attractive domestically, therefore increasing net exports and aggregate demand further. In addition, the increase in exporters’ profits could be used to innovate products and increase workers’ wages, which may later help to increase economic growth. However, if imports on which Japan is heavily reliant become more expensive, then there may be no suitable domestic suppliers, meaning that real output may suffer.
This type of expansionary policy benefits from relatively minimal political interference, especially in comparison with fiscal policies. The policy is comparatively flexible because it is implemented by the central bank rather than the government, so it is altered without political motives. In addition, as the central bank meets each month the policy will be well monitored and easier to change, whereas large changes to fiscal policies tend to only take place once a year in the annual budget. This means that time lags are likely to be shorter than those involved in fiscal policies.
However, monetary policy is not necessarily successful because consumption and investment levels rely on a variety of factors other than money supply and interest rates. For instance business and consumer confidence is extremely important in assessing the potential increase in aggregate demand. It is therefore fortunate for Japan that, ‘the public has largely cheered the economic initiatives,’ and, ‘business confidence among Japan’s biggest manufacturers surged in the past three months.’
In addition, monetary policy is restricted because if the borrowing rate is already close to zero then it cannot be lowered any further as negative interest rates would cause money
Therefore, if the central bank were to buy bonds excessively then there may become ineffective in achieving economic growth and low inflation.
Implementing a policy that improves the attractiveness and accessibility of domestic loans may have little effect on the economy as a result of the globalisation of the financial markets. For instance currently most firms and households are able to borrow money from other countries, this weakens the effectiveness of domestic monetary policy choice.
Overall it seems that this form of monetary policy in Japan is likely to help improve its economic position, by moving towards less deflation and high rates of economic growth. This is because this policy could encourage increased investment, consumption and exports, which are all components of aggregate demand. Also the positive expectations of the Japanese population means that they should stop delaying purchases, so aggregate demand should increase. However, issues including interest rates already being low and potential increases in import prices remain concerning for Japan. This monetary policy is likely to benefit the economy, however, the overall success of the economy is still dependent on other economic policies included in ‘Abenomics.’
Word count: 748