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The Effects on Expected Real Interest Rates and Expected Rates of Inflation through QQE September 8, 2015 Kikuo Iwata D...

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The Effects on Expected Real Interest Rates and Expected Rates of Inflation through QQE September 8, 2015

Kikuo Iwata Deputy Governor of the Bank of Japan

Chart 1

Regime Change to Inflation Targeting  What does the term "regime" mean in economic policy?  Inflation and deflation are ultimately "monetary phenomena" ⇒ Price stability can be achieved through monetary policy  Setting the price stability target "2 percent in terms of the year-on-year rate of change in the consumer price index (CPI)"

Chart 2

Tangibility of "Policy Regime Change" Quantitative and Qualitative Monetary Easing

Actions

Commitment

・Increase in Quantity

Clear commitment that the BOJ "will achieve the price stability target of 2% at the earliest possible time, with a time horizon of about 2 years."

Increase the monetary base1 at an Expansion annual pace of about ¥80 trillion (particularly through purchases of JGBs).

・Change in Quality Purchases of riskier assets (JGBs with longer remaining maturities, ETFs and J-REITs).

Expansion

Note: 1.Money supplied directly from the central bank to the financial system.

Chart 3 Lowering Expected Real Interest Rates through Working on Inflation Expectations(1) Real costs of borrowing, taking into account price changes (Borrowers' subjective expectations)

Subjective forecast based on respective price projections

Visible in financial markets or over the counter

Expected real interest rates = Nominal interest rates Downward - Expected rates of inflation pressure by the QQE

Chart 4 Lowering Expected Real Interest Rates through Working on Inflation Expectations(2)

Nominal yield curves 2.5 (%)

2

1.5

1

0.94

Introduction of Comprehensive monetary easing (October 2010)

0.61

Introduction of QQE (April 2013)

0.38

August 2015

0.5

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

years

Chart 5 Lowering Expected Real Interest Rates through Working on Inflation Expectations(3)

Expected real interest rates = Nominal interest rates Analysis 2: The natural yield curve

- Expected rates of inflation Analysis 1: Has Trend Inflation Shifted?

(References) Kaihatsu, S. and J. Nakajima(2015), ”Has Trend Inflation Shifted?: An Empirical Analysis with a Regime-Switching Model,” Bank of Japan Working Paper Series, No.15-E-3. Imakubo, K., H. Kojima, and J. Nakajima(2015), ”The natural yield curve: its concept and measurement,” Bank of Japan Working Paper Series, No.15-E-5.

Has Trend Inflation Shifted? (1)

Chart 6

 Trend inflation is the private sector's perception about the level at which inflation is expected to prevail in the medium to long run.  It serves as a practical measure of whether inflation expectations remain anchored in line with the price stability target.  The authors assume regimes for the trend inflation at one-percent intervals, and estimate the probability of the trend inflation being in each regime. Inflation rate = F(previous inflation rates, trend inflation, output gap) + error term.

Chart 7

Has Trend Inflation Shifted? (2) Posterior regime probability of trend inflation %

-2%

-1%

0%

1%

2%

3%

100

80

60

40

20

0 85

90

95

00

Zero interest rate policy

05 Quantitative easing

10 Comprehensive monetary easing

14 Q4 QQE

Chart 8

Has Trend Inflation Shifted? (3) Posterior estimates of trend inflation % Trend inflation (weigthed average)

4

Realized inflation

3 2 1 0 -1 -2

-3 85

90

95

00 Zero interest rate policy

Note: The shaded area indicates the one-standard-deviation band.

05 Quantitative easing

10 Comprehensive monetary easing

14 Q4

QQE

Has Trend Inflation Shifted? (4)

Chart 9

Historical decomposition of realized inflation % 4

Shock Output gap

3

Trend inflation

2

Realized inflation

1

0

-1

-2

-3 85

90

95

00

Zero interest rate policy

05 Quantitative easing

10 Comprehensive monetary easing

14 Q4

QQE

The Natural Yield Curve (1)

Chart 10

 The natural yield curve extends the idea of the natural rate of interest defined at a specific maturity – such as the overnight rate – to one defined for all maturities.  Short-term nominal rates have hit the zero lower bound and the focus of monetary policy has shifted to the entire yield curve.  The natural yield curve enables us to measure not only the effects of conventional monetary policy through short-term interest rate control but also those of unconventional monetary policy through government bond purchases and forward guidance.

Chart 11

The Natural Yield Curve (2)

Yield curves during each of the monetary easing programs 2

Zero interest rate policy (1999-2000) %

Quantitative easing (2001-2006) 2



Natural yield curve 1

1

0

0

-1

Actual real yield curve

-1

-2

-2 5

10

years

5

Comprehensive monetary easing (2010-2013) % 2

2

1

1

0

0

-1

-1

-2

-2 5

10

years

10

years

QQE (2013- ) %

5

10

years

Chart 12

The Natural Yield Curve (3) The 10-year natural yield and actual real yield % 3

2

Natural yield

1

0 Actual real yield

90bps1

-1

-2

95

97

99

01

Zero interest rate policy

03

05

Quantitative easing

Note: 1. The difference from 2013/Q1.

07

09

11

Comprehensive monetary easing

13

14/Q4

QQE

Chart 13

The Natural Yield Curve (4)

The interest rate environment and firm’s funding conditions Indicator of the interest rate environment:aggregated information on the interest rate gaps for all maturities 10

%

8

%pts Indicator of the interest rate environment

↑Accommodative

20 15

6 10 4 5

2 0

0

-2

-5

-4 -10 -6 ↓Contractionary

-8

Funding conditions (right scale)

Downward shift Bending

-15

Steepening -10 00

01

Zero interest rate policy

02

03

04

Quantitative easing

05

06

07

08

09

10

11

12

Comprehensive monetary easing

13

14

-20 Q4

QQE