In the old days, when globalization did not unify the economy and financial systems, it may have come as a surprise that the actions of a central bank in distant Japan caused turmoil in Western markets earlier this week. In the global context of the post-pandemic era, the war in Ukraine and the energy crisis, rampant inflation and recession on the cusp of most economies, it reveals the intractable dilemmas facing central banks around the world and the tricks they are doing to manage them. They are currently navigating uncharted waters as, after years of extreme growth policies, they are simultaneously raising interest rates and reversing quantitative easing, and the reaction of economies and markets is unknown.

A slight change in Japan’s monetary policy could cause a shock around the world.

The problem is illustrated by the ambivalent stance of the Bank of Japan and its outgoing Governor Haruhiko Kuroda, who, after six consecutive years of negative interest rates and extensive bond purchases, have attempted to make minimal changes in monetary policy in the direction of a possible rate hike in the future. In an effort to avoid a disproportionate market reaction, the central bank governor said “that means we’re going to raise rates.” The market reaction—not just Japanese bonds, but also 10-year US Treasuries, 10-year German treasuries, the dollar against the yen, and even the European stock markets—was largely driven by one factor: Japan is still the only major economy , which did not raise interest rates despite facing the highest inflation in 40 years of just 3.6%.

His move fatefully signals a widespread end to loose monetary policy as the ECB, the Federal Reserve, the Bank of England and even central banks in emerging markets, Latin America, Africa and Asia raise interest rates at the risk of sending their economies into recession or further deepening. a fairly inevitable recession. And, of course, in many central banks the ambivalence, more or less explicit, is their common feature with the Bank of Japan. The risk of a recession and its aggravation due to successive interest rate hikes is a kind of sword of Damocles over the ECB, which decided ten days ago to raise interest rates again, but 50 basis points less than originally planned. Persistent rumors of all kinds, including speculation about a possible halt to interest rate hikes, have prompted ECB President Christine Lagarde to relentlessly repeat that more hikes are imminent, that the bank will not stop unless inflation approaches its 2% target. that interest rates, which the market believes will reach peak interest rates, somewhere between 3% and 3.25%, are not enough to bring down inflation.

Japan’s Bitter Experience of the “Lost Decade”

Anyone familiar with the ECB’s, the Federal Reserve’s and the Bank of England’s aggressive rate hikes this year will be surprised to learn that the Bank of Japan’s actions have shocked markets around the world. It simply weakened the central bank’s tightly controlled yields on Japan’s long-term debt, its 10-year bonds, allowing it to rise or fall by 0.50%, down from 0.25% so far.

The Land of the Rising Sun has the bitter experience of raising interest rates in late 1989 to fight a housing bubble. As a result, its once-prosperous economy plunged into stagnation and what is commonly referred to as Japan’s “lost decade”. In the 1980s, the Japanese economy grew at a rate close to 4%, while US GDP grew by just over 3%. However, in the fall of 1989, the “bubbles” that formed in the stock market and the real estate market began to burst. From the fall of 1989 to August 1992, share prices collapsed by 60%, while real estate prices steadily fell throughout the 1990s, reaching a dizzying 70% drop in 2001. For almost the entire decade from 1991 to 2001, and largely as a result of rising interest rates, the Japanese economy experienced a toxic cocktail of unusual slowdown, persistent deflation, and a credit crunch.

Since then, Japan has been trying to avoid a repeat of this protracted crisis by using public money to restructure bank balance sheets and prevent both deflation and inflation from getting out of control so as not to repeat the stagflation of the 1990s. lies in the persistent and over-the-top clarifications that central bank chief Haruhiko Kuroda accompanied his decision on Tuesday. “This move is not a rate hike,” he stressed, although the market sees it as a sure first step towards a hike in 2023. Mr. Kuroda has repeatedly stressed that a move to tighten monetary policy would be premature until a significant rate hike occurs. wages are fixed.

The Fed gives the order and says it must hurt a lot

“I hope this will put an end to negative interest rates, because then we will stop relying on central banks for everything. We now know that negative interest rates don’t work. End of story.” The categorical statement belongs to Stephen Miller, a former BlackRock executive and now the head of the investment company GSFM Pty. Perhaps, to some extent completely and with some exaggeration, he reflects the reality that since the global financial crisis, the debt crisis eurozones and beyond, central banks have taken on perhaps a disproportionate effort to support their economies.Governments have taken other initiatives only since the pandemic and especially now, in the face of the energy crisis, and they play an expanded but mostly fire-fighting role.

How delicately this balance is now sought by central banks in an attempt to contain inflation and avoid a deep recession is reflected in the language they choose when announcing their monetary policy decisions. US Federal Reserve Governor Jerome Powell, for example, has repeatedly shrugged off economists’ warnings about the risk of a recession due to successive increases in borrowing costs. In announcing her decisions, she repeatedly came across as unfathomable cynicism when she preferred to say bluntly in a standard press conference that the Federal Reserve had to “cause a lot of pain” to stop inflation from rising. Earlier in September, when everything was showing that despite the looming recession, the US labor market remains extremely resilient, with unemployment at a historically low level of 3.7%, the Fed predicted that its policy to stop inflation would lead to a rise in unemployment to 4.4%, which in practice means another 1.2 million unemployed, 1.2 million people who will lose their jobs due to Fed policy. At the time, Jerome Powell stated that “an increase in unemployment would be a lesser evil than a long period of high inflation.”

To a person unfamiliar with the central bank, and especially with the terminology that central banks commonly use, he would come across as a bully with an aggressive temperament. However, for those who follow the machinations of the central bank, the situation looks extremely complicated. Just as it does at the ECB, the Fed is very concerned about what overall pressure it might put on the US economy beyond raising interest rates. The US Federal Reserve has been reducing its portfolio for several months now by reducing bonds accumulated during years of so-called quantitative easing. He was the first to decide to abandon this unconventional policy, and the first to decide a few days ago to continue with a more lenient interest rate hike. In a sense, he gives the order, and the ECB and the Bank of England follow it. She will probably be the first to see results.

Guarantees

Unlike the ECB president, who announced a move to tighter monetary policy, Bank of Japan Governor Haruhiko Kuroda tried to convince the markets that “easing the yield limit on his country’s 10-year bonds is not an interest rate hike.”

A warning

Just six days before the Bank of Japan shocked the markets, the ECB president accompanied the euro interest rate hike with another of her repeated warnings that “we expect further increases to reach the 2% target” and reiterated it. “Inflation remains very high.”

First signs

With a difference of several hours from the ECB, US Federal Reserve Governor Jerome Powell announced another increase in dollar interest rates, expressed satisfaction with the first signs of inflation deflation, but stressed that “it will take much more signs of the index decline to feel confident.”

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