Kuroda’s BOJ Is A Test Case Of Monetary Policy Limit

By Masaki Kondo, Bloomberg Markets live reporter and analyst

What are the limits of monetary policy? The answer may lie in the Bank of Japan’s experience.

For close to a decade now, a weaker exchange rate has complemented Japan’s loose monetary policy as the central bank sought to revive growth and inflation. The reason? Years of rock-bottom interest rates and an abundance of cheap funds had long lost their impact.

Japan’s real effective exchange rate is at the lowest since at least 1994 and this is probably a deliberate — albeit indirect — policy move on BOJ Governor Haruhiko Kuroda’s part. But it remains to be seen if it’s enough to rouse Japan’s economy from decades of anemic growth and inflation.

The answer to that question has far-reaching implications. As the risks of a global downturn increases, central banks will have to contend with the issue of how much policy easing can do to stimulate consumption and investment.

In this respect, Japanese stocks may provide a clue as to the effectiveness of BOJ’s monetary policy. The so-called Fed Model shows the Topix index’s earnings yield premium is about 8 percentage points over that of 10-year local government notes. That’s 5 percentage points above the S&P 500’s.

It’s worth noting that the falling yen has also widened Japan’s trade deficit given that exporters had moved their production hubs abroad. Still, a prolonged bout of currency weakness may encourage them to return. Rising US-China tensions as well as the Biden administration’s initiative for a semiconductor alliance that includes Japan, South Korea and Taiwan will provide additional tailwinds.

Should Kuroda prove that a weaker currency is an effective easing tool, Japan’s stocks may further outperform their developed peers.

And if he doesn’t, this may serve as an example to other central banks that monetary policy has its limits.