Opinion

Lessons from the Bank of Japan for the euro area

It was feared that after the consumption tax hike, the inflation expectations would be dampened too much and the Bank of Japan would miss its target. The just released Q3 data seem to confirm that fear. Governor Kuroda was explicit on the aim to change the mindset of the public arguing that “… we could face a delay in eradicating the public's deflation mindset”.

By: Date: November 25, 2014 Global Economics & Governance Tags & Topics

It was feared that after the consumption tax hike, the inflation expectations would be dampened too much and the Bank of Japan would miss its target

The decision of the Bank of Japan end of October 2014 to significantly expand its asset-buying programme came as a surprise. The yen weakened and stock markets rallied. The decision taken with only a small majority by the board of the Bank of Japan was taken to show the resolve of the BoJ to increase inflation expectations so that inflation eventually moves to two percent. It was feared that after the consumption tax hike, the inflation expectations would be dampened too much and the Bank of Japan would miss its target. The just released Q3 data seem to confirm that fear. Governor Kuroda was explicit on the aim to change the mindset of the public arguing that “… we could face a delay in eradicating the public’s deflation mindset”.

Which lessons can the euro area and the European Central Bank draw from this recent episode of Japan’s monetary policy? I would emphasize three central lessons. The first lesson is that it is very difficult to change inflation expectations and get the public move from a deflation to an inflation mindset. This is a very important lesson for the ECB. Inflation expectations in the euro area have fallen already significantly. Five-year ahead inflation swaps signal a rate of about 1% instead of the official target of the ECB of close but below two percent. The ECB needs to avoid that markets lose even more confidence in the ECB to achieve its target. The more inflation expectations get disanchored, the more difficult it will become for the ECB to change them again. The BoJ had to step up an already very large quantitative easing programme. If the ECB wants to prevent such a scenario, it should be bolder with its policies now to ensure that inflation expectations revert quickly back to the target. 

The euro area should not neglect the role of fiscal policy. In Japan, an increase in taxes is unavoidable to achieve fiscal policy credibility

Second, the euro area should not neglect the role of fiscal policy. In Japan, an increase in taxes is unavoidable to achieve fiscal policy credibility. However, the timing of the last increase weakened the economic dynamics too early. One can also question whether the consumption tax is really the best tax to raise in those circumstances. Fiscal consolidation is also necessary in a number of euro area countries. Weaker countries are particularly fragile in a monetary union due to the absence of a central bank lender of last resort and therefore have to re-gain fiscal credibility. However, the simultaneous consolidations across the euro area until 2013 was a heavy burden on growth and contributed to the disinflationary momentum. Euro zone policy makers have now reduced the speed of consolidation. It would be useful if the new European Commission was successful in its plans to create a stimulus with Eurozone-level investment funded by common fiscal resources.

Finally, the Bank of Japan teaches us how controversial monetary policy measures can become. The narrow majority in the BoJ governing council still allows the BoJ to take bold decisions. In the euro area, a narrow majority is more difficult to sustain. This is particularly the case, if the opposing camps in the ECB governing council cut across countries of the North and of the South of the euro area. While this does not necessarily make the ECB non-operational, the resulting political pressure would certainly be higher. The risk is that the ECB would not be able to ever take decisions as bold as the BoJ is taking currently. In other words, once the Eurozone gets stuck in deflation, it may become even more difficult than in Japan to get out of it.

Important lesson to the euro area that monetary policy should act decisively while the euro area investment programme planned ought to be implemented

Overall, the recent episode in Japan provides the important lesson to the euro area that monetary policy should act decisively while the euro area investment programme planned ought to be implemented. The lesson from Japan’s experience of the 1990s should be taken on board: bold and early policies on banking reform and productivity enhancing structural reforms should be part of the policy package.


This is an upcoming opinion in Nikkei. Published in English with permission.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read article Download PDF More on this topic

Policy Contribution

pc-20-16_page_01

What impact does the ECB’s quantitative easing policy have on bank profitability?

This Policy Contribution shows that the effect of the ECB’s QE programme on bank profitability has not yet had a dramatically negative effect on bank operations.

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: November 30, 2016
Read article More on this topic More by this author

Blog Post

sd-12177-_0028bea2-web

Can public support help Europe build distressed asset markets?

Distressed asset investors can relieve banks of their NPL overhang and offer valuable restructuring expertise, although banks will need to realise a further valuation loss. Regulators could do a lot to support the growth of this market.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: November 29, 2016
Read article More on this topic More by this author

Opinion

Alicia García-Herrero

Japanese banks and US$ liquidity: Squeezed between expensive deposits and the BoJ

For the last few years, Japanese banks have aggressively expanded their assets overseas, which has helped increased their stubbornly low profitability even after the introduction of negative interest rates by BoJ. Such a successful overseas strategy, profitability-wise, may be at risk due to US$ liquidity developments at a global level.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: November 28, 2016
Read article Download PDF

Working Paper

cover

Reform of the European Union financial supervisory and regulatory architecture and its implications for Asia

This Working Paper reviews recent developments in the EU’s financial supervisory and regulatory architecture with a view to draw out lessons for regional financial regulatory architecture in Asia.

By: Zsolt Darvas, Dirk Schoenmaker and Nicolas Véron Topic: Finance & Financial Regulation, Global Economics & Governance Date: November 17, 2016
Read article More on this topic More by this author

Blog Post

Schoenmaker pic

Stealing London’s financial crown would bring both benefits and responsibilities

After Brexit, several major cities across the EU27 are looking to take over London's financial activity. While there are plenty of benefits in hosting a major financial centre, it also comes with significant risks and responsibilities.

By: Dirk Schoenmaker Topic: Finance & Financial Regulation Date: November 17, 2016
Read article Download PDF More on this topic More by this author

External Publication

claeys-ref-2016

What role for the financial markets in Europe?

The European European financial system is too strongly bank-based. How can it be rebalanced to become favourable to growth and employment again? (This paper is only available in French).

By: Grégory Claeys Topic: Finance & Financial Regulation Date: November 16, 2016
Read article More on this topic More by this author

Opinion

Silvia Merler

An Italian take on banking crisis

The year 2016 has not been good to Italian banks. While resilient to the first wave of financial crisis in 2008, due to their low exposure to US sub-prime products and to the fact that Italy did not have a pre-crisis housing bubble, they have been suffering much from the euro sovereign crisis and the ensuing deteriorating economic conditions.

By: Silvia Merler Topic: Finance & Financial Regulation Date: October 27, 2016
Read article More on this topic More by this author

Opinion

Nicolas Véron

Breaking the vicious circle

Nicolas Véron argues that EU banking union can only be complete if the vast amounts of domestic sovereign debt held by many banks are reduced

By: Nicolas Véron Topic: Finance & Financial Regulation Date: October 21, 2016
Read article More on this topic More by this author

Blog Post

MariaDemertzis1 bw

A framework for thinking about bad loans

An important guiding principle in resolving non-performing loans (NPLs) should be to ensure that viable debt remains serviced, while non-viable debt gets resolved. We present here a framework to approach the issue.

By: Maria Demertzis Topic: Finance & Financial Regulation Date: October 18, 2016
Read about event

Past Event

Past Event

Innovation and economic reform in Europe and Japan

This event is co-organised by Bruegel and the Kobe University Graduate School of Economics.

Speakers: Jonathan Cave, Beñat Bilbao Osorio, Zsolt Darvas, Taiji Hagiwara, Rémy Lecat, J. Scott Marcus, Yoichi Matsubayashi, Koji Nakamura, Tamotsu Nakamura, Georgios Petropoulos, Guntram B. Wolff and Kazufumi Yugami Topic: Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 18, 2016
Read article More by this author

Blog Post

Silvia Merler

The Deutsche Bank Frenzy and what it says about European banks

What’s at stake: The IMF recently published its Fall Global Financial Stability Report, which points to a decrease in short-term risk but building of medium-term ones. At the same time, European market has been nervous last week on the news that Deutsche Bank (Germany’s biggest bank) has been demanded USD14bn by the US Department of Justice to settle allegations that the bank mis-sold mortgage-backed securities before the financial crisis. While reports point to a possible USD5.4bn settlement, this turmoil raises a question of whether the European financial system is still weak, eight years since the crisis. We try to summarize the reactions in the blogosphere.

By: Silvia Merler Topic: Finance & Financial Regulation, Global Economics & Governance Date: October 10, 2016
Read article Download PDF More on this topic

Policy Contribution

pc-17-16

Fiscal capacity to support large banks

This Policy Contribution outlines a fiscal cost scenario for the recapitalisation of large banks during a severe systemic crisis.

By: Pia Hüttl and Dirk Schoenmaker Topic: Finance & Financial Regulation Date: October 3, 2016
Load more posts