How does the BoJ influence inflation?
The Bank of Japan will attempt to raise or lower inflation by raising or lowering money supply. If it wants to bring inflation up to target, then its policies will be designed to increase the supply of money and spending across the economy. If it wants to bring inflation down it will implement policies that are designed to do the opposite.
The main way the BoJ attempts to influence inflation is by adjusting the interest rates it offers to financial institutions – including the rates it pays on deposits made with the bank and charges for loans. This then affects the interest rates offered by commercial banks to businesses and consumers, so higher rates can lead to increased saving, and lower borrowing and spending across the economy.
In recent years, the bank has pushed interest rates towards their lower limits in attempt to coax inflation towards target – a necessary measure after decades of low inflation and, in some years, deflation. However, with its policy tools having only limited success, the bank introduced a package of unconventional measures called ‘quantitative and qualitative monetary easing (QQE) with yield curve control’ in 2016. This includes:
1. Quantitative easing with yield curve control
Yield curve control is a policy through which the bank sets a target for the ‘long-term interest rate’ – the rate paid on 10-year Japanese government bonds (JGBs). To control this rate, the bank buys and sells JGBs on the open market through a quantitative easing programme, with the amount bought and sold adjusted over time to keep yields in line with the target.
The yield target for 10-year JGBs was set at 0% in September 2016, meaning the bank is aiming to drive prices to a level where these bonds will offer no return on investment. It hopes that this will encourage financial institutions to stay away from 10-year JGBs – and sell any they currently own – to free up capital for investment elsewhere. In theory, this should increase spending across the economy and cause inflation to rise.