As central bank decisions go, the one Bank of Japan Governor Kazuo Ueda will make this week may be the most complicated in fashion history.
All thanks to Federal Reserve Chairman Jerome Powell, European Central Bank Chair Christine Lagarde, or People’s Bank of China Governor Pan Gongsheng, but none of them have been in Ueda’s shoes.
At the monetary policy meeting on July 30-31, Ueda will have to decide whether to break with 25 years of zero interest rates and 23 years of quantitative easing by including a significant rate hike on the scoreboard. And stick to the movement, whatever the consequences.
Worse, smart economists can present nuanced abstractions and convincing arguments to open one of three doors.
Door #1: Do nothing. Now that Japan avoids recession and domestic demands during the crisis, it is not the right time to tighten its financial policy. With China exporting deflation, Europe stumbling and the Fed slowly cutting rates, Team Ueda can make a strong case for doing no harm.
Gate 2: rate increase of 25 basis points. This is the most popular option, as evidenced by currency investors driving the yen higher. This concept is supported by economists who say that Japan is in a position to adopt a “normalized” rate policy. And the story that the Bank of Japan would push the yen up to 170 to the dollar.
Gate #3: Divide the difference. This trend would see Ueda’s team reduce its purchases of bonds or stocks without a major change in financial policy. Given the point of uncertainty, this option would be the most likely.
Whatever happens, Ueda’s team is right to look in the mirror. In 2023 there were countless opportunities to raise rates. Each time he objected. Each time, the yen fell as a hedging budget idea, they had the green light to short the BOJ.
Ueda is not the only senior Bank of Japan official who has an explanation for regret. It was his predecessor, Haruhiko Kuroda, who had the most leeway to begin normalizing rates. Starting in 2013, Kuroda expanded the balance of the Bank of Japan in unprecedented ways.
In 2018, the Kuroda BOJ increased the central bank’s balance sheet to $5 trillion, exceeding the length of the economy as a whole. However, Kuroda refused to plan a way out of his long-standing regime of quantitative easing, blaming Ueda.
So what will Ueda do? It’s an enigma. This will most likely also apply to Ueda and key BOJ board members.
Complicating the situation is Tokyo’s political establishment. In April, Japanese Prime Minister Fumio Kishida expressed concern about the yen’s excessive weakness. “It’s vital that currencies move stably based on fundamentals, and excessive volatility is undesirable,” Kishida said.
More recently, Taro Kono, Minister of Digital Transformation, warned that the prices of a weaker yen outweighed the benefits. “The currency is a challenge for Japan,” Kono told Bloomberg, adding that “the yen is too reasonable and we want to bring it back. “
Despite this, the party represented through Kishida and Kono has long advocated a weak yen. In fact, it is the only economic policy that Liberal Democratic Party governments have had since the mid-1990s.
It remains an open question whether the LDP is willing to live without the support of a weak yen. It is also unclear whether Ueda will have the courage to keep him company after a rate hike.
Ueda recalls the experience of Toshihiko Fukui, who 18 years ago toyed with the political changes envisioned by Ueda. In 2006 and 2007, then-Governor Fukui managed to raise rates twice.
But those measures did not last long. In 2008, Fukui’s successor cut rates to 0 and reinstated QE. In 2013, Kuroda came in and oversized the BoJ balance sheet and accelerated QE. Of course, Japan has seen some expansion here and there over the last decade. The yen and the resulting excess liquidity pushed stocks to all-time highs. Household income, a lot.
In the end, an entire quarter-century of QE turned a Group of Seven economy into the worst dependence on corporate welfare that fashion economics has ever seen. Now it’s up to Ueda to devise a 12-step program to rid Japan Inc. of the monetary sauce. Unfortunately for Ueda, there are no models to follow, no case studies to consult, and no gray-bearded Nobel economists to turn to.
Ueda is making things up as he goes along, especially as his team heads to this week’s high-stakes political meeting. Anyone who tells you they know which of the three gates the BoJ will decide deserves not to be taken seriously. The only thing we can say for sure is that Ueda is faced with a decision that his teammates are glad he doesn’t have to make.