Huge scale action at the Bank of Japan

The Japanese economy performed remarkably well during the Great Depression of the 1930s. After two years of double-digit deflation in 1930 and 1931, Japan escaped from the deflationary trend, in 1932. Over the next five years it went on to experience robust economic growth and mild inflation, even as depression persisted in many other parts of the world. Korekiyo Takahashi, a veteran finance minister serving in his fifth-seventh term, brought about an early recovery for Japan by prescribing a combination of an expansionary exchange rate and fiscal and monetary policies. Just months after his return as minister, Takahashi moved Japan off the gold standard to depreciate the yen. Over the next few years he prescribed fiscal stimulus and an easy monetary policy. Takahashi’s policy has drawn attention from economic historians, economists, and policymakers from around the world since.

Ben Bernanke, among others, has spoken highly of Takahashi’s accomplishments: “Finance Minister Korekiyo Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies in the early 1930s.”

Mr Abe began the latest policy drive, it should be noted that in the broad it is at least in principle consistent with the prescriptions advocated by Paul Krugman and Ben Bernanke in the early 2000s, with the latter, in a well reported speech in 2003 (after he had already joined the FOMC board) suggesting that Japan should adopt an inflation level target, and that the key to reflation was greater coordination between the Bank of Japan (BoJ) and the Ministry of Finance.

The arrival of “Abe economics” stimulated the imagination of the global investment community and catapulted Japan to the top of the investor pops and whilst the ultimate success of the current push to aggressively reflate the economy is contestable it is clear that Mr Abe has been inspired by the reflation seen in Japan during the 1930s when a combination of expansionary exchange rate, monetary, and fiscal policies saw Japan escape the Great Depression well before the United States. So the latest policy moves by the BoJ are very significant.

The BoJ has announced that it will purchase c$78.6bn worth of bonds a month and this compares with expectations of Y 5.2tn. This is big in absolute terms and to provide context, this is twice as big relative to GDP as the Fed’s QE.  More importantly, the BoJ plans to double the monetary base in two years to a level that approximates 50% of GDP, as compared with slightly less than 20% in the U.S. currently.  At its next meeting, the BoJ is likely to announce open-ended quantitative easing.  To the surprise of many, only one board member voted against any of the new policy proposals.

Some commentators are suggesting that following more than a decade of corrosive deflation, Mr Kuroda’s bold first move at the Bank of Japan may be sufficient to chart a new way forward for Japan’s economy and certainly Mr Kuroda has wasted no time having been appointed just twenty nine days before the Bank of Japan’s policy meeting.

In effect the bank will be purchasing a large proportion of available high quality assets in Japan, almost guaranteeing that domestic investors would need to look elsewhere – including offshore.

Krugman and Bernanke when at MIT often referred to the need to be rationally irresponsible if policy is to ensure that the economy successfully escapes the liquidity trap and puts an end to deflation. It is very much in this spirit that the new BoJ has moved to implement a policy on the scale almost unthought of until now.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla