Case Closed

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Summary

Last week, I pointed to a Financial Times headline that suggested the yen was falling on rumors of a cut in the interest rate on reserves (which is already negative).

Tuesday, Tyler pointed to another FT story, this time claiming the exact opposite.

A few weeks ago, I did a post suggesting that the BOJ appears to be giving up on its 2% inflation target.

Last week, I pointed to a Financial Times headline that suggested the yen was falling on rumors of a cut in the interest rate on reserves (which is already negative):

In the long run, you want to rely on a worldview that allows you to make sense out of the myriad news events that are reported each day. I believe that framework is market monetarism. Let's take an example, a headline from today's FT:

Yen dives on talk of negative rates on loans

If you relied on the mainstream media, that headline would make no sense. "Wait, weren't we told on Twitter that Sumner was foolishly attached to the notion that negative IOR was expansionary, despite all indications to the contrary? If so, how are we to understand this headline?" On the other hand if you relied on market monetarism, there would be no cognitive dissonance to deal with. It would all make perfect sense.

Tuesday, Tyler pointed to another FT story, this time claiming the exact opposite:

Ten weeks after BoJ governor Haruhiko Kuroda startled both financial markets and parliamentarians with Nirp, the yen has appreciated by some 8 per cent against the dollar. The stock market has rebounded sharply this month, however the Topix bank index remains 11 per cent lower since the advent of Nirp.

Under such a policy, risk assets were supposed to rise, but instead demand for Japanese government bonds rallied, rewarding the risk averse. Meanwhile, even finance ministry officials concede that the deflationary mindset is more entrenched than ever. There is agreement that Nirp has backfired and such an unsustainable monetary policy cannot support growth, let alone help financial asset prices.

Who to believe, the FT, or the FT? Answer, the FT. Today's Financial Times provides the results of about as dramatic an event study as you could ever want:

Yen surges and stocks hit as BoJ stands pat

So much for the theory that negative IOR is contractionary. And the concurrent fall in global stock markets puts another nail in the theory of "currency wars" and "beggar-thy-neighbor." The failure of the BOJ to devalue the yen is going to hurt the US and European economies.

Why so much confusion? Because people forget that while a lower policy rate is expansionary on any given day, low rates are also an indication that money has been too tight. This paradox is resolved if we make the (quite plausible) assumption that when the Wicksellian natural rate is falling, the policy rate usually tends to fall more slowly, making policy effectively tighter (as in 2008). And when the Wicksellian rate is rising, the policy rate usually tends to rise more slowly, making policy effectively looser (as in the 1970s).

It doesn't take a genius to understand that you evaluate a policy's effect by looking at the immediate market reaction, not market moves in the following weeks, which could be caused by 101 factors. Oh wait, I guess it does take a genius.

Here's a graph showing the fall in the yen last week on rumors of a rate cut, and the more than 3% gain today on the market disappointment at the BOJ's inaction:

A few weeks ago, I did a post suggesting that the BOJ appears to be giving up on its 2% inflation target. I suggested that this meeting would give us an answer:

What should Japan do? I suppose they should do whatever they want to do. It doesn't make much sense to target inflation at 2% if you don't want to target inflation at 2%.

The more interesting question is what should they want to do? I'd say NGDPLT. But they seem to have other ideas.

Either way, we should have an answer by the end of the month.

Today we got the answer. The FT also reports the following:

The BoJ also changed its guess of when inflation will reach 2 per cent from the "first half of fiscal 2017" to "fiscal 2017." Any further delay would mean admitting Mr. Kuroda will not reach the target during his term in office.

The whole point is to not adjust the forecast, but rather to adjust the policy instruments. A very disappointing performance by Mr. Kuroda. That's not to say it couldn't be worse, he has gotten Japan out of its nearly two-decade bout of deflation. But he'll need to be far more aggressive at the July meeting if he doesn't want to lose all credibility. As it is, the BOJ lost a significant amount of credibility today. Here's Bloomberg:

A majority of economists surveyed by Bloomberg had predicted some action to counter a strengthening yen that had cast a shadow over the outlook for wage gains and investment spending. The explosion of volatility shows how investors have singled out central banks as the key driver for global financial markets...

"It's the central banks that still set the course," said Jan Von Gerich, chief strategist at Nordea Bank AB in Helsinki. "Even slight deviations from what people are expecting are enough to trigger market moves..."

"The BOJ had an opportunity to at least temporarily short-circuit the yen trend but failed to act," said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. "It has provided the green light for further yen strength in the near-term."