Professor, Aoyama Gakuin University; former Governor, Bank of Japan; former Vice Chairman, Bank for International Settlements.
Has the experience of the crisis changed your view of the central bank policy tool kit?
Governor Shirakawa: My view has not changed that much. I guess that this assessment is different from the frequently-heard view of U.S. and European policy makers.
This difference is because: (1) Japan experienced its own severe financial crisis well ahead of the global crisis that began in 2007; and (2) the Bank of Japan (BoJ) developed and deployed a range of policy tools to address this earlier challenge.
For instance, in early 2000, the BoJ introduced its own version of a term auction facility (TAF). It also provided forward guidance regarding future policy rates, engaged in a massive expansion of the central bank balance sheet, and introduced the purchase of asset-backed securities, just to name a few examples. More or less the same measures were adopted in other countries during the global financial crisis.
Separately, in the fall of 1997, the BoJ decided to provide an unlimited volume of liquidity to Yamaichi Securities, a Japanese version of Lehman Brothers. And, in 2003, it purchased corporate equities held by financial institutions.
In the global financial crisis, the BoJ did adopt several new measures, including the purchase of commercial paper, corporate bonds, exchange-traded funds and real estate investment trusts. Yet, viewed from the perspective of a central bank that had previously deployed various unconventional policy measures, I would say that the policy tool kit itself had already expanded significantly before the global financial crisis.
Having said this, there are important lessons to underscore. One is that central banks reconfirmed the importance of their role as lender of last resort. By acting aggressively as lender of last resort, central banks averted the collapse of the financial system and for that matter, a deflation like the one in the 1930s. Of course, central banks are constrained by a legal framework and are not immune to political and social influence. Yet, each central bank found innovative ways to maintain financial stability despite these difficulties (although these novel policies pose difficult questions for the accountability of central banks in a democratic society).
In this regard, the most impressive new policy measure in the global financial crisis was the arrangement of swap lines between the Federal Reserve and other central banks. This measure was quite effective. I am struck by the fact that these swap lines were opened in only a few days and without any press leakage in advance.
As for unconventional monetary policy measures aimed at macroeconomic stability, I believe that their effect is modest. This tentative conclusion is based on facts rather than on theory. If we look at the path of real GDP in the post-bubble period relative to the peak of the bubble up to now, there is no difference between Japan’s bubble in the late-1980s and the U.S. bubble in the mid-2000s.
Last but not least, I would like to emphasize the central banks’ efforts to reduce settlement risk – through real-time gross settlement (RTGS), delivery-versus-payment (DVP) and payment-versus-payment (PVP) in foreign exchange trade settlement – as great contributions to maintaining financial stability. The importance of these efforts is underestimated. I wonder what would have happened if we had been forced to face the financial crisis without these.
Where should we be looking now for financial stability risks given this experience?
Governor Shirakawa: The current assessment of financial stability risk that I often hear is that – because of the improved capitalization and increased liquidity buffers of financial institutions – there is no imminent threat. If I stress “imminent,” I do not disagree with this view.
But, at the same time, we have to recognize that financial crises over the past 20 years or so have taken on a different form every time. We cannot grasp the system’s vulnerability just by looking at average data. What is important is the distribution of positions and the correlation of risk factors. In this regard, we have to be attentive to the fact that we have been through a very long period of low interest rates. And, while I cannot specify the exact form of positions that could threaten financial stability, it is natural to think that various forms of potentially risky positions that we do not see clearly could be accumulating. Also, we have to be attentive to the behavioral changes in the government that these financial conditions could bring about.
In this regard, what is worrisome is the possibility that the potential growth rate in advanced economies is declining as a result of the decline of the working-age population. When we look back at the history of financial crises or at the history of inflations, these phenomena tended to occur when we did not recognize the fact that potential growth was slowing. At this moment, I am not concerned about inflation. But we have to be attentive to the risk stemming from the combination of prolonged low interest rates and lower potential growth rates. The rate of return that investors hope to achieve or are asked to achieve is shaped by the past mindset fostered in the recent period of high growth. And, investor attempts to secure high returns tend to create financial imbalances. My impression is that people still do not fully recognize the impact of the declining working-age population on growth and returns. The debate about secular stagnation and its implication for monetary policy should be placed in this context. Monetary easing brings future demand to the present but the cumulative amount of demand that can be brought safely forward is determined by the potential growth rate.
What do we need to do to preserve the benefits of global finance?
Governor Shirakawa: After the global financial crisis, trust in finance was undermined. Restoring people’s trust in finance itself is crucial. In this regard, again, what’s important is to avoid bubbles and financial crises. Following the global financial crisis, there were many measures introduced in the area of regulation and supervision to make finance safer. Most of these measures are desirable. But, it is not enough to have a certain liquidity or capital buffer for a given amount of debt. What is more important is to avoid too much debt itself. And, we have to discuss this issue more seriously.
In this regard, we need some rethinking of the conduct of monetary policy. We have to wonder whether the current regime of monetary policy has a bias toward the creation of too much debt. For instance, if monetary policy is overly focused on price stability in the short term without paying due attention to the stability of the financial system, it may lead to excess debt creation by giving the sense that accommodative policy will extend into the future. Also, if central banks have too strong a preference for low volatility, providing insurance against a fall in asset prices, then this may lead to excess debt creation. Of course, macroprudential policy is important, but I don’t think it will be effective without a corresponding monetary policy adjustment.
The international dimension of monetary policy also is important. Global financial conditions have become increasingly important in affecting domestic economies. And these conditions are jointly determined by the actions of all central banks. Of course, each central bank is constrained by a mandate from its country. But, there is no reason to believe that such local optima automatically lead to a global optimum. In this regard, I would cite two phenomena. The first is the implication of central bank monetary policy being conducted with a focus on core consumer prices excluding food and energy. Global commodity prices are influenced by global financial conditions as well as real factors. But, if central banks focus on a core measure of prices, this means that central banks inadvertently neglect some of the effect of their collective actions and thus may create a bias toward global easing. Second, I am concerned with the implications of monetary policy at the zero bound for nominal interest rates. Because the key remaining transmission mechanism of monetary easing is the exchange rate, when countries implicitly aim at depreciating their currencies, they collectively create a global easing bias.
Of course, there is no simple solution to these difficult problems, but at least some rethinking of monetary policy is needed.