THE Bank of Japan (BoJ) pioneered the process known as quantitative easing (QE) in 2001-06, when it massively boosted the reserves that commercial banks held at the central bank. Its verdict on how well QE worked then ought to interest policymakers today. It will also discomfort them. For all that it propped up Japan's creaking banking system, QE did not really improve the economy nor end the country's deflationary mindset (see chart).
That much was acknowledged by Masaaki Shirakawa, the bank's governor, during a speech in Shanghai this summer. In a forthcoming paper*, Shigenori Shiratsuka, one of the BoJ's senior economists, re-examines Japan's experience of QE in light of the extraordinary monetary-policy measures taken by central banks since last year (the BoJ among them). His research finds many common elements between the BoJ's policy responses from the late 1990s onwards and unconventional measures currently being taken around the world. It also issues warnings about the limitations and potential side-effects of QE.
Mr Shiratsuka's arguments vary, at least in part, from those of people like Ben Bernanke, the chairman of America's Federal Reserve, who says there are conceptual differences between Japan's previous form of QE and the “credit easing” that the Fed is currently engaged in. In January Mr Bernanke said that the Fed's approach was focused on buying up loans and securities—that is, on the asset side of its balance-sheet. By contrast the BoJ's approach was focused on the quantity of bank reserves held at the central bank—or the liability side of its balance-sheet.
Mr Shiratsuka, however, sees “striking similarities” between these approaches because the asset and liability sides of central banks' balance-sheets interact so closely. On the asset side, QE works through the buying up of private-sector and government instruments. When private markets seize up, central banks step in. But this activity is financed by an increase in commercial-bank reserves, or liabilities, created by the central bank. These reserves provide a buffer for banks when liquidity dries up in financial markets. Although there may be differences in the size and composition of central-bank balance-sheets, these depend on the state of the economy, particularly the financial system, rather than the mechanics of QE.
The closer the similarities between Japan's first bout of QE and the extraordinary measures now being taken by central banks, the more relevant the results of the BoJ's earlier experiment. Many central bankers, after all, set great store by the policy. David Miles, a member of the Bank of England's rate-setting committee, said last month that quantitative easing was having an impact not just in financial markets in London but “in high streets and factories and homes throughout the UK”.
The BoJ's experience of QE may leave less room for optimism, however. The ample provisioning of reserves, and a commitment to maintain zero interest rates for a long time, boosted liquidity, which helped stabilise Japan's financial system. It also brought down credit spreads. But Mr Shiratsuka argues that the benefits of stabilisation were not transmitted outside the finance industry. Nor did it change the perception in financial markets that deflation would persist. It also produced unwelcome side-effects, such as a deterioration in the functioning of the money markets because banks preferred to transact with the BoJ rather than with each other.
Mr Shiratsuka draws several conclusions. First, quantitative easing involves the use of both sides of a central bank's balance-sheet to counter shocks hitting the economy. Second, it is only a temporary policy response. The use of a central bank's balance-sheet to restore liquidity to financial markets simply buys time until banks restructure their own balance-sheets. Third, massive intervention in private markets by central banks risks distorting those same markets, and the longer QE persists, the more such distortions become apparent. That may explain why bosses at the BoJ are keen to start unwinding unconventional monetary policies soon, a move some government officials oppose. The bank kept mum about exit strategies after a policy meeting on October 14th, but it cannot do so for much longer.
