Bank of Japan Introduces New Monetary Policy

In an attempt to finally spark inflation in the Japanese economy, the Bank of Japan announced that it will keep the interest rate on its 10-year government bonds at zero through additional monetary policy. However, the central bank also announced that it will continue expanding its existing monetary policy of ¥80 trillion in annual bond purchases, resulting in two approaches that may conflict if bond prices drastically fall. In that case, the Bank of Japan may need to purchase more than the ¥80 trillion specified in order to drive up the price and keep the yield at zero.

With this new policy, the Bank of Japan is entering relatively uncharted territory in terms of controlling the long-term debt market. A number of potential issues arise as a result of the new plan: first, whether or not they can actually control the yield of the government bonds. The traditional view is that the yields are set by market forces, and the central bank intervening may lead to unforeseen consequences. The second issue is the concern that control of the government bond market may cause investors to leave the market, causing the market to lose its highly liquid nature. Nevertheless, the radical policy coupled with the divergence of opinions within the board members leads us to believe that the Bank of Japan is becoming increasingly desperate in its campaign to raise inflation; this will eventually lead to more risky policy decisions.



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