When the Bank of Japan (BOJ) announced a policy of negative interest rates in 2016 by charging interest on reserve deposits, yields on Japanese government debt fell precipitously. The yield on 10-year Japanese government bonds fell to a record negative 0.135%, below the BOJ’s negative 0.1% reserve deposit rate. With the BOJ purchasing government bonds at an unprecedented annual rate of more than 80 trillion yen as of 2021, it has become exceedingly difficult for the BOJ governor, Haruhiko Kuroda, to deny that these policies are not a form of government debt monetization. We explain why below.
Independent Central Banks
Any government that issues its own currency (e.g. not Greece) could, in theory, continue to create money without limit. The idea that governments either have to tax or borrow in order to spend is really just a consequence of the legal and institutional infrastructure we, as a society, have created. Things could be otherwise, but when the monetary printing press is in the hands of politicians, the temptation to inflate currency is strong.
There is the fear that excessive printing of money and subsequent spending will lead to inflation, then hyperinflation, and then eventual abandonment of the currency. Further, assuming the limited nature of economic resources, if the government has unlimited amounts of money, then it could potentially control all of those resources, essentially “crowding out” the private sector. Obviously, this is problematic for some, and any attempt to compete with the government in utilizing resources leads to a bidding up of the price of those resources.
To mitigate these fears, modern governments have delegated the responsibility of money issuance to independent central banks, hoping to keep fiscal policy considerations separate from monetary policy ones. Since the primary goal of central banks is to maintain price stability (usually interpreted as low and stable inflation of around 2% a year), governments cannot depend on central banks to fund their operations and must either rely on tax revenue or, like everyone else, borrow money in private markets.
The willingness of the private sector to hold government debt will depend on the return and riskiness of that debt relative to alternative investments. Any government that issues debt far in excess of what it could collect in taxes is perceived as an excessively risky investment and will likely have to pay increasingly higher interest rates. Thus, a government’s fiscal policy has definite market constraints.
However, central banks have the power to manipulate interest rates. In fact, it is interest rates that they are targeting when they carry out their daily open market operations (OMOs) to achieve price stability. The central bank typically states an interest rate target it believes will help it achieve its inflation target, and then it increases or decreases the reserves of commercial banks through asset purchases—typically short-term government bonds—in order to achieve that target. Quantitative easing (QE) has extended these purchases to other assets like mortgage-backed securities (MBS) as well as longer-term government debt.
The central bank then, by purchasing government bonds in private markets can keep interest rates low, and in a sense, monetize government debt. However, these daily OMOs are not what the more hawkish types have in mind when they talk about government debt monetization. What they have in mind is when central banks, by using their power to create money, accommodate massive deficit spending by the government, inflating the government’s debt to levels where it is not clear how or if it will ever be paid off. Such a move causes one to wonder how independent the central bank really is.
The Bottom Line
At a level of government debt that is more than 266% of its gross domestic product (GDP), Japan is the second-most indebted nation in the world. With bond yields in negative territory, the government is now getting paid to borrow. By charging private banks interest on reserves held at the BOJ, Japan’s central bank is effectively transferring wealth, and thereby the ability to control the economy’s resources, from the private sector to the public sector. It amounts to a “helicopter drop” of new money that is channeled into the economy either through tax cuts or direct government spending. Sounds a lot like debt monetization.
Yet, while the potential for inflation is worrisome for the monetary hawks, inflation is actually Kuroda’s intended goal. With deflationary pressures plaguing the Japanese economy, Kuroda has stated, “What’s important is to show people that the BOJ is strongly committed to achieving 2% inflation and that it will do whatever it takes to achieve it.”
He is still trying to maintain the BOJ’s primary monetary policy objective; it just so happens that the Japanese government is the only economic agent willing and able to spend, thus creating the aggregate demand that is so badly needed. He just doesn’t want to call what he is doing “debt monetization” in hopes that people will still believe that the BOJ maintains, at the very least, a modicum of independence.