Global: The difference between central bank literature and actual policies
2024-04-04
■ The Bank of Japan seeks to normalize policy, while other central banks in Europe and the United States emphasize restrictive policy stances
■ Both sides intend to gradually adjust policies to achieve a long-term neutral interest rate, showing clear differences
Last month, the Bank of Japan (BOJ) in front of Kuroda the governor reviewed the monetary policy framework after about 11 years in office and decided to move towards normalizing monetary policy, lagging far behind other central banks. However, in terms of outlook, based on current economic and price expectations, loose monetary conditions are expected to continue in the short term. At the same time, other countries in Europe and the United States that have normalized monetary policy are turning to keep policy interest rates unchanged and have entered a discussion stage based on future data considerations, such as when to start considering future interest rate cuts. Interestingly, among the European and American central banks that are considering future interest rate cuts, unlike the Bank of Japan, they currently emphasize maintaining a fully restrictive monetary policy stance.
The key to understanding the seemingly contradictory claims between the Bank of Japan's pursuit of further interest rate increases in pursuit of normalizing monetary policy, and its insistence on restrictive monetary policies by other central banks in Europe and the United States that are beginning to consider rate cut lies in the concept of a "neutral interest rate." The neutral interest rate refers to the neutral interest rate level that is neither too hot nor too cold. Furthermore, it is not an actual observed rate but an estimate based on economic and financial theory. Generally speaking, the value of the nominal neutral interest rate in the long run is based on the natural interest rate and the Fisher equation, which is the sum of the potential growth rate and the expected inflation rate. The goal of central banks in various countries is to guide policy interest rates to achieve nominal neutral interest rates in the medium and long term to achieve price stability and achieve an equilibrium state of the economy.
Other countries in Europe and the United States have admitted that through substantial interest rate increases since 2022, policy interest rates have exceeded the nominal neutral interest rate level. Although the inflation rate is still well above the target level, as the effects of monetary tightening begin to appear, a slowdown in economic growth and a deceleration in inflation are being observed, so it is foreseeable that the policy interest rate will return to the nominal neutral interest rate level. Maintaining a sufficiently restrictive monetary policy means gradually cutting interest rates to keep the policy interest rate above the nominal neutral interest rate level, which does not negate the interest rate cut itself. In contrast, Japan's policy rate is well below the nominal neutral rate, requiring multiple rate hikes over the medium term. The Bank of Japan's advocacy of continuing a loose monetary environment does not mean that it denies rapid interest rate increases like those in Europe and the United States, but it implies that it will gradually advance the pace of monetary tightening, rather than denying further interest rate increases. Neither is a statement about the future direction of monetary policy but about the pace of policy adjustments.
■ Both sides intend to gradually adjust policies to achieve a long-term neutral interest rate, showing clear differences
Last month, the Bank of Japan (BOJ) in front of Kuroda the governor reviewed the monetary policy framework after about 11 years in office and decided to move towards normalizing monetary policy, lagging far behind other central banks. However, in terms of outlook, based on current economic and price expectations, loose monetary conditions are expected to continue in the short term. At the same time, other countries in Europe and the United States that have normalized monetary policy are turning to keep policy interest rates unchanged and have entered a discussion stage based on future data considerations, such as when to start considering future interest rate cuts. Interestingly, among the European and American central banks that are considering future interest rate cuts, unlike the Bank of Japan, they currently emphasize maintaining a fully restrictive monetary policy stance.
The key to understanding the seemingly contradictory claims between the Bank of Japan's pursuit of further interest rate increases in pursuit of normalizing monetary policy, and its insistence on restrictive monetary policies by other central banks in Europe and the United States that are beginning to consider rate cut lies in the concept of a "neutral interest rate." The neutral interest rate refers to the neutral interest rate level that is neither too hot nor too cold. Furthermore, it is not an actual observed rate but an estimate based on economic and financial theory. Generally speaking, the value of the nominal neutral interest rate in the long run is based on the natural interest rate and the Fisher equation, which is the sum of the potential growth rate and the expected inflation rate. The goal of central banks in various countries is to guide policy interest rates to achieve nominal neutral interest rates in the medium and long term to achieve price stability and achieve an equilibrium state of the economy.
Other countries in Europe and the United States have admitted that through substantial interest rate increases since 2022, policy interest rates have exceeded the nominal neutral interest rate level. Although the inflation rate is still well above the target level, as the effects of monetary tightening begin to appear, a slowdown in economic growth and a deceleration in inflation are being observed, so it is foreseeable that the policy interest rate will return to the nominal neutral interest rate level. Maintaining a sufficiently restrictive monetary policy means gradually cutting interest rates to keep the policy interest rate above the nominal neutral interest rate level, which does not negate the interest rate cut itself. In contrast, Japan's policy rate is well below the nominal neutral rate, requiring multiple rate hikes over the medium term. The Bank of Japan's advocacy of continuing a loose monetary environment does not mean that it denies rapid interest rate increases like those in Europe and the United States, but it implies that it will gradually advance the pace of monetary tightening, rather than denying further interest rate increases. Neither is a statement about the future direction of monetary policy but about the pace of policy adjustments.