Thursday, March 19, 2009

Federal Reserve given Lessons from Japan

Yesterday the Federal Open Market Committee, the board that votes on policy rates at the Federal Reserve Bank buried it’s lede. After making the predicted moves of keeping the Federal Funds rate near zero and extending $750 billion to buy agency mortgage-backed securities, the FOMC announced a move upon long-term interest rates.

Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

The move places the Fed clearly in the position of quantitative easing, although they prefer the term credit easing. The policies involve continuing to expand reserves at a central bank even after the policy rate has hit zero. This is done in the hopes of using the balance sheet to impact the economy. The US’s efforts to use new discount windows like TALF are examples of such a program.

The Fed’s decision reverberated at a IMF conference in Washington this morning. The conference, “Japan’s Policy Response to a Financial Crisis: Parallels with the United States Today,” offered insights from those who had dealt with a long episode of quantitative easing in Japan earlier this decade.

Before introducing speakers, the IMF’s James Gordon expressed that the planners doubted if an event on Japan would be relevant by the time it could be arranged. Yet rather than recover the US economy has taken on more characteristics of Japan’s “Lost Decade.”

Hiromi Yamaoka, the Alternative Executive Director for Japan at the IMF and a former Bank of Japan (BoJ) official, reviewed the Japanese experience. While many see the zero bound as a great constraint for central banks, Yamaoka referred to the period of low rates between 1998 and 2005 (Japan held a rate of zero for most of 1999 and 2000 and a rate of .25 following) as “the busiest time in my life as a central banker.” While Yamaoka stressed that the US has been more aggressive than Japan, reaching the zero bound in just over 18 months, a feat that took Japan nine years, he explained that they have yet to detail their entire direction. Speaking to the FRB’s preferred terminology, Yamaoka said that “the complete definition of credit easing is not yet widely shared.”

Alternative monetary policy alone will not solve the crisis, said Yamaoka. He pointed to the 1998 case of Yamaichi Securities, at the time one of Japan’s largest securities firms. To bailout the firm, the BoJ provided a large loan with little collateral. The firm became insolvent and the BoJ lost 111.1 billion yen.

According to Adam Posen, the deputy director of the Peterson Institute for International Economics, investing in rocky firms, like the American auto industry can pay off in the short run. While his preliminary research here shows some positive correlation between the “wastefulness” of a project and it’s short-run multiplier effect. Taking a longer run view, Takatoshi Ito of the University of Tokyo said the government should instead direct fiscal stimulus toward areas like health care, and education where efficiency gains are possible.

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