Thedifference between how conventional monetary policy works andquantitative easing (QE), the reasons for the use of QE by the Bankof Japan, and the possible effectiveness of such a policy instimulating economic growth and ending deflation.
Differencesbetween conventional monetary policy and quantitative easing
AsAnthony(2013) notes,monetary policies are some of the alternative measures, thegovernment may pursue to improve the market rates in the economy.These interests play a special role in ascertaining the stability ofthe nation through maintaining the amount of money in circulation.This in return reflects other factors of the economy suchorganisation choosing to invest rather than divest. Othermacroeconomic variable that are affected by this endeavour are theunemployment and inflation. Most government believe that by using themonetary policies, they will influence the amount of money in supplyhence controlling the level of inflation at a specific percentage
Onthe other hand, there are instances when the monetary policies mayfail to work in curbing the inflation rate. In such a case, thegovernment opts for unconventional policies also known asquantitative easing. This happens through flooding financialinstitution with funds and hopes to urge them to improve theirlending effort. Quantitative easing is used by the central bankswhenever a market lacks the enough liquidity and controls. Thegovernment may intentionally purchase specific financial assets henceimproving the value of those assets. In such a case, the governmentachieves the intention of stimulating the economy by making theseassets more valuable and competitive. Quantitative easing is a threeway prong it improves the value of the assets, while allowing thegovernment to achieve a specific interest rate through marketperformances(Koo, 2011).
Reasonsfor the use of QE by the Bank of Japan
Byusing quantitative easing technique, the bank of Japan was able tostimulate the already stagnant economy. Bank of Japan made itpossible for banks to have more funds hence raising the consumerprice index to hit a stable Zero. Further, the move made it possibleto create a high deflation considering the banks had much more fundsto offer to their customers. These funds were as a result of sellingrevaluation of assets. Quantitative easing also reflected on to theexchange rate of the Japanese currency through a sharp increase. From2001 to 2006, the Japanese created another concept that aims toimprove the stagnation of the Japanese economy hence allowing it toperform continually and improve its rating(Joseph, 2013).The plan would involve aggressive quantitative easing through massivepurchase of long-term investment assets such as bonds and other formsof equities. If indeed the government enabled the entire stakeholderto play their role, the market environment would improve followingthese tenets (Aoki, 2012).
Theimpact of Japanese fiscal policy on Japan’s government debt, thepredictions of standard economic theory for the impact of such alevel of government debt on Japanese interest rates, and anexplanation for any difference between these predictions and theactual level of interest rates in Japan. The Japanese Government hasa far higher level of debt than the governments of Greece, Italy,Spain, Portugal or Ireland. How is this possible, without a resultingloss of confidence in Japan and rising Japanese interest rates?
Since1990, the GDP scale has been on an increasing trend. This has led tothe Japan government adopting several measures to curb aggregatedemand. Japanese economy has always relied on lower taxation ratewhich in return has affected the disposable income. To remedy theincreasing debt, the government has pegged its debt scale on GDP.This in returns means since the debt is half, the gross the worth ofthe debt is low (Aoki, 2012). It further means monetization of thisdebt burden might have a little effect to the fiscal sustainabilityas the problem of the debt majorly is threaded to any futureliabilities rather than the current liabilities. Even if the rate ofthe debt is higher, the Japanese currency is stronger and stable.Similarly, the rates are stable only making a small change(Anthony, 2013).
Theimpact of Japanese policy on debt
Japanesepolicies as noted by the graph below have been highly effective inallowing the country to attain a high level of debt in the country.The government of Japan in a span of almost two decade has applied avariety of methods to make this dream a reality. Surprisingly, thelevel of inflation has been at an almost constant value of aboutthree percent.
Source:(International Monetary Fund, 2009)
Theeffect of lower tax
AsBen,Chu (2013)the effect of lower level of tax in Japan has made significantcontribution to the disposable income hence leading to the averageconsumers to be willing to spend, while the saver in the countryinvest much of their extra funds that they do not consume. A changein the level of taxation has also reflected on how the governmentchooses to raise funds to finance its economy. Japanese governmenthas a high level of debt and while the GDP is on an increasing trend,the government has to opt for other alternatives to finance its GDP.
Differencesbetween predictions of interest rates and real interest rates
Ben(2013) observes that there is a huge difference between nominal andreal inflation rate. In fact, in some cases there is notation of aJapanese yen depreciating. Interest rate has had a huge impact onJapan. As of 2010 the level of Inflation in Japan was at negative twopoint two percents while in 2008 the interest was at two point twopercent. This probably implies the rate of real interest incomparison to nominal rate is higher.
Reasonsof Japanese government has higher debt than some Europe governments,is it means that Japan has loss confidence?
Japanis noted to have the highest level of gross debt in comparison toother nations. Probably this is as a result of events such asearthquakes and the tsunami that occurred in 2011 since thegovernment had to make huge borrowings to support itself. Otherevents such as nuclear leakages have made some investors also shunaway from the country possibly explaining the high level ofinvestments the government makes to salvage the calamities.
Anthony,K. 2013. `Abenomics`Serving Up The Same Old Medicine In Japan?OnlineAvailable at:
http://www.npr.org/blogs/parallels/2013/08/01/207861379/abenomics-serving-up-the-same-old-medicine-in-japan>[accessedon 13thOctober, 2014]
Aoki,M. 2012. ADesirable Inflation Targeting Policy in a Deflationary Economy: TheCase of Japan.NewYork, Wiley.
Ben,C. 2013. CanAbenomics really save Japan?Online Available at:
http://www.independent.co.uk/news/business/analysis-and-features/can-abenomics-really-save-japan-8565135.html>[accessedon 13thOctober, 2014]
Koo,R. C. 2011. The world in balance sheet recession: causes, cure, andpolitics. Real-worldeconomic review(58), 19-37.