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Japan's Rate Hikes Miss Mark: Money Supply is Key
22 Jul
Summary
- Monetary policy success hinges on money supply, not interest rates.
- Japan's low rates reflected tight money and weak economic activity.
- BOJ's fund provisioning strategy boosted money growth and inflation.
Monetary policy's effectiveness is determined by changes in the money supply, not interest rates, a principle frequently misunderstood by investors and policymakers.
For years, observers believed Japan's ultra-easy monetary policies, characterized by near-zero interest rates, failed to stimulate spending. This led to the Bank of Japan's governor, Kazuo Ueda, ending yield curve control and implementing five interest rate hikes, bringing the rate from -0.1% to 1% by March 2024.
However, a monetarist perspective reveals this focus on interest rates is flawed. Low rates in Japan historically signaled tight money and deflationary pressures. Between 2000 and 2020, Japan's broad money (M2) growth averaged a mere 2.6% annually, resulting in weak nominal GDP growth.
A significant shift occurred during the Covid-19 pandemic. The Bank of Japan's "Fund Provisioning" strategy, offering interest-free loans to banks for on-lending to firms, boosted broad money growth to a peak of 9.6%. This action predictably led to a surging stock market, recovering real GDP, and inflation reaching 4%, demonstrating the direct impact of money supply changes.
