HomeBank of Japan and the Most Exotic Experiment in Central Banking

Bank of Japan and the Most Exotic Experiment in Central Banking

One of the most interesting countries in the world, Japan has long been the economic powerhouse in Asia. As a major exporter, it led the Asian economies throughout previous crises and is expected to do the same in the future.

The Japanese culture is one that poses many threats to its economic performance. Unlike any other economy in the world, Japan does not benefit from immigration and the positive effects it can bring. For instance, in Germany and the United Kingdom, immigration is credited to a sharp reversal in demographic trends. Not in Japan.

As such, traditional economic and monetary policy decisions that work in some other parts of the world may simply not have the same effect in Japan due to its uniqueness. We have some clear examples – one of the most famous being the Quantitative Easing (QE), where national banks buy their own government bonds to ease monetary policy and bring inflation close to the 2% target. QE is credited with most of the economic recovery post the 2008-2009 Great Financial Crisis, and it is the tool of choice by all central banks in the developed world as the pandemic hit.

However, it did not function in Japan. For decades, the Japanese inflation is close to or below zero, and the same solution did not work. As such, the Bank of Japan is involved in all kinds of monetary experiments, unprecedented both in their size and nature.

Buying Equities – Another Way to Support the Economy

For more than a decade, the Bank of Japan (BOJ) has been involved with the purchase of equities. Currently the institution has an equity portfolio close to the value of $840 billion. The intent is to boost economic growth through the wealth effect and in the meantime the central bank became the largest owner of domestic stocks.

Buying stocks as a diversification of a central bank’s portfolio is not unusual – the Swiss National Bank (SNB) is doing it too, but for different reasons (i.e., it buys stakes in foreign companies to sell CHF and buy other currencies in an effort to stop the CHF appreciation). However, buying national stocks is something that has never been done before. Hence, we do not know how this one will end – with the central bank owning the entire stock market? What happens when the Bank of Japan stops buying equities – will the market crash?

Imagine the Federal Reserve of the United States or the European Central Bank starting buying equities in the U.S. stock market, respectively in the Euro area – how disruptive such a process is?

As the size of the Bank of Japan’s portfolio grows, we will find out soon. Sure enough, other central banks watch closely how this Japanese experiment ends.

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