Tuesday, January 13, 2009

We're not Japan but its still expensive

In a speech today before the London School of Economics, Federal Reserve Chairman Ben Bernanke sought to distance the Fed's current course from that of the Bank of Japan in the late part of the 1990's and early 2000's.

From August 1999 to July 2000, Japan kept it's benchmark interest rate at zero. This zero-bound prevented the short-term rate from being used as a method to inject liquidity. Instead the Bank of Japan (BoJ) engaged in quantitative easing--the practice of holding more reserves than needed to maintain the overnight rate. The process caused the Bank of Japan's real assets as a share of GDP to peak at just over 30 percent in late 2005.

The US now looks to be on the same path. In December, the Fed abandoned its single figure Federal Funds rate target and instead took up a range of 0-.25%, closing in on the Bank of Japan. As the figure below shows, the BoJ used to be an outlier in global policy rates but all rates have moved down quickly this year. (UK--yellow, US-dark Blue, BoJ-bottom, European Central Bank--Purple, Australia--thin blue)

Yet, says Bernanke the US is "credit easing" not quantitative easing. Says Bernanke:

Our approach--which could be described as "credit easing"--resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. Indeed, although the Bank of Japan's policy approach during the QE period was quite multifaceted, the overall stance of its policy was gauged primarily in terms of its target for bank reserves. In contrast, the Federal Reserve's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses.

He's right. The Fed has taken on a lot of assets, from bank equity to less savory commercial paper and GSE debt that it's never held before. He's also aware of why he's doing it and that just monetary policy may not be enough.
In a 2002 speech about Japan, Bernanke noted that:

As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan's long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy.

So there we are. Monetary policy seems to be on the right track, being even more aggressive than the BoJ. Structural reform, at places like the SEC, may be much harder.

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