In a prior blog post, I outlined some important guidance Bank of Japan (BOJ) deputy governor Kikuo Iwata outlined in a speech on October 18. We continue that discussion here with a look at how Iwata sees the BOJ’s activities manifesting in changing inflation expectations and portfolio allocations of Japanese households.
Let’s start with why Iwata believes the BOJ’s monetary easing program known as quantitative and qualitative monetary easing (QQE) lifts inflation expectations:
The reason behind the lift in inflation expectations owes much to the market expectations that a sharp increase in the monetary base … will eventually lead to an increase in bank lending, and hence an increase in the amount of money (i.e., sum of cash and deposits) circulating in the economy. If the money in the economy increases, people will expect that it will be used partly for the purpose of purchasing goods and services, and eventually the rate of inflation will start to pick up as well.1
Iwata showed a graph of nominal interest rates, expected real interest rates on inflation-adjusted bonds, and then the break-even inflation rate that is implied from the difference between the two interest rate series. One can see expected real rates have been on the decline. Although to be fair to prime minister Shinzo Abe, the decline in real rates started with Abe’s election in November, when the break-even inflation rate was close to 0.50%—it has since risen well above 1%. The expected real interest rate in September is really not much lower than when the BOJ began its QQE program in April.
Interest Rates and Inflation Expectations (1/1/2012–9/30/2013)