Here’s the conceit.
“Fiscal reconstruction has become all the more important” because of Prime Minister Shinzo Abe’s aggressive monetary and fiscal stimulus measures, the report said, while warning that a loss of fiscal rectitude could send bond yields higher and undermine the efforts of the Bank of Japan to stimulate the economy.”
Aggressive monetary and fiscal stimulus? Loss of fiscal rectitude? Have we gone all Freudian, worrying about Japan’s anal sphincter?
Here’s our WSJ’s take on Japan’s loss of anal rectitude:
“…the central bank launched an aggressive bond-buying program in April. The BOJ’s change in stance initially pushed bond yields down. But uncertainty over the impact of buying on such a huge scale—up to 70% of newly issued debt—saw yields bounce back up. As the country’s currency, the yen, broke above 100 to the dollar earlier this month for the first time in more than four years, bond yields climbed along with equity prices. When they hit 1% on May 23, a level not seen in more than a year, the equity market’s upward march halted.”
Bernanke’s QE has been described in exactly the same terms: aggressive bond-buying. What exactly does that mean? Uncle Ben enters your home with an AK-47 and demands to buy all your bonds?
I don’t think so. Rather, the Fed and the Bank of Japan offer to buy bonds at a price you like. At a higher price, you sell; by the mathematics of prices and yields, that means returns on bonds will be low. Indeed, that is the goal of QE—no matter how ill-advised the policy might be.
Note the impact in Japan when “markets” reacted against that nation’s new version of QE: yields rose all the way to 1%!. Read that carefully. One Percent. Oh, those damned Bond Vigilantes are holding the entire nation hostage! Better tighten the nations’s fiscal belt to keep that fiscal sphincter under control. Otherwise, the Vigilantes might demand a whopping 1.1%! Who knows, maybe even a bankrupting 1.2%!
All of this silliness comes on the heels of a new report by an advisory panel to Japan’s finance minister that warned “Unless the government moves ahead with and makes progress in fiscal consolidation, the BOJ’s policy could be viewed as an act of debt financing by the central bank, causing bond yields to rise, and canceling out the effects of its monetary easing.”
Oh My Goodness: debt financing by the central bank! Could cause bond yields to rise! Vigilantes on strike.
No, you morons. Government deficits always increase reserves in the banking system. That places downward pressure on the overnight interbank lending rate. Selling bonds normally relieves that pressure. But if you’ve already achieved ZIRP (zero rate target) then you don’t need to sell them.
For operational reasons, you might be required to sell bonds (this is a typical requirement) even with a ZIRP. In that case, the bonds will sell at a small premium over what the central bank pays on reserves. If the overnight rate rises above target, that triggers an open market purchase by the central bank. “Debt financing” by the central bank! Oh, my!
So-called “debt management” policy can complicate matters a tiny bit. If the treasury tries to sell, say, 30 year treasuries but the market prefers 2 year bonds, then you can drive the rate on the longer maturities up a bit. Maybe all the way to 1.1%!
Is this scary? Is there an alternative? Of course there is. Leave excess reserves in the banking system and simply pay a base interest rate on them. Or, sell 30 day bills and pay a slightly higher rate. Or 5 year maturities. And so on. The farther you go out the maturity structure, the greater the potential for capital losses when the central bank reverses policy and starts to raise overnight interest rates. That is why it is normally hard to push long term sovereign government rates below about 2%.
In any case, the Central Bank can always determine the rate on bills or bonds, no matter what the maturity, if it deals in those maturities in a sufficient quantity. That is not usual behavior and probably is not desirable. But it is a policy choice.
Is there any chance that Japan will become subject to the whims of Bond Vigilantes, who vote against the solvency of Japan, Inc? Of course not. Japan is a sovereign currency issuing nation. It will make all payments as they come due. The interest rate it pays on reserves and bills and bonds is always potentially under its control—all it needs to do is to exert its discretionary power to set the relevant rates.
So the following argument made in the report is pure nonsense:
“The report also noted that a rise in bond yields would also complicate the task of the exiting the so-called quantitative easing program down the line. Under a newly introduced inflation target, the BOJ is obliged to achieve 2% price growth, and the bank has said it would keep its aggressive easing in place until it secures that target. The report said that “even if the BOJ wants to reduce its government bond purchases, it won’t be able to do so unless there are alternative buyers of bonds in the market.” Without private sector buyers, long-term interest rates could go up far beyond levels in line with economic growth rates, the report warned.”
Angels on pinheads. There is little likelihood that there would be no “private sector buyers” as banks with excess reserves will prefer to exchange them for higher-earning bonds. The Bank of Japan can always keep long-term rates low, but even if it did not want to do so the Treasury can simply refuse to issue long-term debt, focusing on short maturities instead.
(Usually the treasury deals with special banks—the dealer banks—that are pre-committed to buying treasuries. So the only question is over price, anyway, not over whether the market will take treasuries.)
Finally, the WSJ noted “The report urged the government to produce a credible and concrete fiscal reform road map that would include specific numerical targets, rather than just expressing a strong determination.”
But haven’t we recently learned that the Reinhart&Rogoff and Alesina arguments in favor of “fiscal consolidation” were all based on faulty empirical work and faulty theoretical reasoning?
Yes, we did.