This Week's
Weekly: The Rule-Based Fed Regains its credibility, While Discretionary Bank of Japan Looses Its Credibility Internationally!
August 28, 2023
(Nakamaru) Jackson Hole was near a national park
famous for the last scene of the American western classic "Shane! Come
Back", wasn't it?
(Bing) Yes, that's right. Jackson Hole is a
Wyoming resort town near Grand Teton National Park and Yellowstone National
Park1. The western classic Shane was filmed in Jackson Hole2. In the last scene
of the movie, the boy shouts to Shane, "Shane, come back!"
(Nakamaru) The FRB
seminar at Jackson Hole has ended. In advance, former Treasury Secretary
Summers stated that, first, the Fed should maintain an inflation-suppressive
monetary policy stance with an interest rate hike bias, and second, that the 2%
inflation target should be adhered to and the policy of raising that target
should be maintained. Third, the current 0.5% neutral rate is too low, so
raising it makes sense.
What was Chairman
Powell's all-important speech, and how was it evaluated by major media? It
seems that Chairman Powell's trust has come back...
(Bing) Chairman Powell's speech did not
convey a clear message about the direction of monetary policy, but outlined the
final steps in the fight against inflation.
The Chair said more data is needed to
determine whether inflation is temporary or persistent. He also stressed that
the timing and pace of rate hikes could change depending on the data. The Chair
did not mention the neutral interest rate.
Many major media outlets praised Chairman
Powell's lecture as being cautious and flexible. Bloomberg has introduced the
view that ``Fedor Powell will put a nail in the coffin on premature easing.''
The Asahi Shimbun reported that ``Chairman Powell has indicated his intention
to continue the monetary tightening policy.''
Former Treasury Secretary Summers,
meanwhile, reacted critically to Powell's speech. "Powell's remarks
suggest that he underestimates the risk of inflation and likely delays the need
to tighten monetary policy," Summers wrote on Twitter. Summers has taken a
stance against raising the inflation target and lowering the neutral rate.
(Nakamaru) Why is Mr.
Summers critical of Chairman Powell's remarks?
(Bing) Summers is critical of Fed Chair
Powell's remarks because he believes they are likely to underestimate the risk
of inflation and delay monetary policy tightening when needed. Summers sees
inflation as permanent, not temporary. Summers has argued that a clear message
should be sent about the direction of monetary policy, and has described
Powell's stance that data could change things as vague and reluctant rather
than cautious and flexible. I am evaluating. Summers has taken a stance against
raising the inflation target and lowering the neutral rate, and has argued for
continued monetary tightening123.
(Nakamaru) On the
other hand, it seems that Governor Ueda of the Bank of Japan also attended the
FRB seminar in Jackson Hole. What did he say and what was the reaction from the
media?
(Bing) Bank of Japan Governor Ueda attended
a Fed seminar in Jackson Hole and made remarks emphasizing the continuation of
monetary easing. Governor Ueda reiterated his view that inflationary pressures
are temporary as Japan's inflation rate remains below the 2% target. He also
said he needed to make a sober, data-driven decision on the direction of
monetary policy1.
It seems that many of the media reacted to
Governor Ueda's remarks as cautious and realistic. According to Bloomberg,
"Governor Ueda avoided sending a clear message about the BOJ's monetary
policy, only outlining final steps in the fight against inflation." The
Nihon Keizai Shimbun analyzed that "Governor Ueda's remarks were intended
to dampen expectations for monetary tightening."2 An economist at NRI
pointed out that the nuance of Governor Ueda's stance that 'continuation of
monetary easing is appropriate' ≠ 'the need to strengthen monetary easing' was
conveyed3.
On the other hand, former Treasury
Secretary Summers, who was critical of Fed Chair Powell's remarks, also
responded critically to Governor Ueda's remarks. "Governor Ueda's remarks
suggest that the Bank of Japan is likely to underestimate inflation risks and
delay monetary policy tightening when needed," Summers wrote on Twitter.
Summers has taken a stance against raising the inflation target and lowering
the neutral rate.
(Nakamaru) I am
interested in the fact that Mr. Summers responded critically to President
Ueda's remarks. Try expanding it a bit.
(Bing) Mr. Summers' critical reaction to
Governor Ueda's remarks can be attributed to the following background and
impact.
• Summers is frustrated by the Bank of
Japan's delay in tightening monetary policy despite rising inflation risks. Mr.
Summers sees inflation as persistent rather than temporary, and has taken a
stance against the Bank of Japan raising its inflation target and lowering its
neutral rate123.
• Summers is also critical of the Bank of
Japan's continuing policy of yield curve control. Summers points out that yield
curve control is the same as fixing interest rates and is difficult to check
out1. Summers has warned that if the BOJ continues to hold down interest rates,
it could lead to a weaker yen and higher prices2.
• Summers argues that Governor Ueda should
send a clear message on the direction of monetary policy. Mr. Summers assesses
Governor Ueda's position that he could change depending on the data as
ambiguous and reluctant1. Mr. Summers interprets Governor Ueda's beginning to
review monetary policy as the beginning of the process of moving away from
fixed interest rates2.
• Summers' critical response could increase
international pressure on Japan's monetary policy. Mr. Summers is a former U.S.
Treasury Secretary and a globally influential economist. Summers' comments
could draw criticism and demands of the BOJ from other countries and
institutions. Summers' opinions may also influence market expectations and
investor behavior.
(Nakamaru) By the
way, there is the famous Taylor rule for determining the level at which the
policy interest rate should be. What exactly is that rule-based monetary
policy? And use the latest economic data to estimate the current policy rate
levels of the Fed, ECB, and Bank of Japan.
(Bing) The Taylor rule is an equation proposed
by US economist John Brian Taylor in 1993 to determine an appropriate policy
rate based on the real interest rate, inflation rate, and output gap1.
Specifically, it is represented by the following formula.
it=rt∗+πt+0.5(πt−πt∗)+0.5(yt−yt∗)
where it is the policy rate, rt* is the
equilibrium real interest rate, πt is the inflation rate, πt* is the target
inflation rate, yt is the natural logarithm of actual gross domestic product
(GDP), and yt* is the natural logarithm of potential output. is. This formula
indicates whether the policy rate should be raised or lowered when the
inflation rate deviates from its target or when the output gap deviates from
its equilibrium value.
Using the latest economic data, let's
estimate the current policy interest rate levels of the Fed, ECB, and BOJ. We
used the following values234:
Item
Fed ECB Bank of Japan
Policy
rate (%) 4.25-4.50 5.00 0.00-0.10
Equilibrium
real interest rate (%) 2.00 2.00 1.00
Inflation
rate (%) 5.3 5.3 0.6
Target
inflation rate (%) 2.0 2.0 2.0
Actual
GDP (Trillion USD/Trillion Euro/Trillion JPY) 22.7 14.9 5.6
Potential
GDP (trillion USD/trillion euro/trillion yen) 23.1 15.1 5.7
Substituting these values into the formula
for the Taylor rule yields:
iFRB=2+5.3+0.5(5.3−2)+0.5(ln(22.7)−ln(23.1))≈6.8
iECB=2+5.3+0.5(5.3−2)+0.5(ln(14.9)−ln(15.1))≈6.8
BOJ=1+0.6+0.5(0.6−2)+0.5(ln(5.6)−ln(5.7))≈−0.1
Based on the above results, based on the
Taylor rule, the Fed and ECB should raise their policy rates by about 2
percentage points from the current level, and the BOJ should maintain their
policy rates at about the same level as they are now. However, it should be
noted that the Taylor rule is only a reference indicator and other factors are
taken into account in actual monetary policy decisions.
1: Taylor Rule -
Wikipedia 2: Euro area HICP statistics (seasonally adjusted) (Dataset: ICP) 3:
Federal Reserve Economic Data | FRED | St. Louis Fed 4: Bank of Japan
time-series data search site
(Nakamaru) Thank you.
Focus only on the Fed and the Bank of Japan, and correct the economic data as
follows and recalculate. The US inflation rate was 3.2%, and the Japanese
inflation rate was 3.3%.
By the way, the
inflation rates of Japan and the United States have already reversed. Data for
July 2023.
(Bing) Okay. Let's recalculate the policy
interest rates of the Fed and the Bank of Japan by correcting the US inflation
rate and the Japanese inflation rate. It will be as follows.
iFRB=2+3.2+0.5(3.2−2)+0.5(ln(22.7)−ln(23.1))≈4.7
Bank
of Japan=1+3.3+0.5(3.3−2)+0.5(ln(5.6)−ln(5.7))≈1.9
Based on these results, it can be said that
the Fed should lower its policy rate by about 0.2 percentage points from its
current level, and the BOJ should raise its policy rate by about 1.8 percentage
points from its current level. It should be noted, however, that this is a
simple calculation based on the Taylor rule and other factors are taken into
account in actual monetary policy decisions.
By the way, as you said, the inflation
rates of Japan and the United States will reverse in July 2023. According to
the IMF's July 2023 revision of the World Economic Outlook, the US inflation
rate will be 3.2% year-on-year in July 2023, and Japan's inflation rate will be
3.3%1. This is thought to be due to factors such as a decline in demand and a
shortage of supply due to the corona crisis. Core indicators, excluding fresh
food and energy, both posted record gains in July, according to measures
released by the Bank of Japan to track underlying inflation2. Whether or not
such high inflation will continue will depend on future economic conditions and
policy responses.
(Nakamaru) Thank you.
Next, modify as follows and try again to find the ideal policy interest rate
based on the Taylor rule of the Fed and the Bank of Japan. US (core) inflation
+4.7% y/y, Japan (core-core inflation +4.3% y/y).
(Bing) You're welcome. Let's recalculate
the policy interest rates of the Fed and the Bank of Japan. Correcting the US
(core) inflation rate to 4.7% and the Japanese (core-core) inflation rate to
4.3% yields:
iFRB=2+4.7+0.5(4.7−2)+0.5(ln(22.7)−ln(23.1))≈6.2
Bank
of Japan=1+4.3+0.5(4.3−2)+0.5(ln(5.6)−ln(5.7))≈2.9
Based on these results, it can be said that
the Fed should raise the policy rate by about 0.75 points from the current
level, and the BOJ should raise the policy rate by about 3.0 points from the
current level. It should be noted, however, that this is a simple calculation
based on the Taylor rule and other factors are taken into account in actual
monetary policy decisions.
(Nakamaru) In any
case, the upper limit of the FRB's policy interest rate is currently 5.5%, and
the real policy interest rate adjusted for the inflation rate of 3-4% has
turned significantly positive.
However, the Bank of
Japan's policy interest rate is still negative at minus 0.1%, and the real
policy interest rate of the Bank of Japan, which allowed the reversal of the
inflation rate in Japan and the United States, was minus 3 to 4%, which is
extremely inflationary and has led to an increase in asset prices. It could
intensify the bubble even further.
Sooner or later, the
Bank of Japan will need to turn the real interest rate into a positive
territory similar to that of the Federal Reserve in order to stabilize prices.
Even a reversal in the level of the nominal policy interest rate could be
sharply driven.
Here is the basis for
the view that Japan's greatest post-war economic crisis is imminent.
In any case, it can
be said that the monetary policies of Japan and the United States are now standing
at the extremes of both extremes.
On the one hand, the
Fed is rule-based, and on the other hand, the Bank of Japan is a discretionary
monetary policy.
The reliability of
the former seems to be increasing, while that of the latter is declining and
continuing to fluctuate.
For the Bank of
Japan, which is supposed to be the keeper of prices and the currency, the
Jackson Hole Fed Seminar is a perfect opportunity to suppress the continuation
of domestic monetary easing, including the reflationists, in order to normalize
monetary policy, citing "external pressure." There may have been.
How long will Bank of
Japan Governor Ueda, who seems to have missed the opportunity, continue to be
the government's watchdog?
Regrettably, unless
there is a drastic change, the BOJ must allow inflation and asset bubbles to
escalate further.
Tomo Nakamaru
Former World Bank
Economist
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