Still dithering over monetary policy

Whether monetary policy should be expansionary or contractionary/neutral is still of great concern for the central banks in the USA and Japan.

The Federal Reserve (USA central bank) has given hints that it will raise interest rates (contractionary!)  in June because the USA economy seems to be moving higher on the upturn of the economic cycle and may soon exceed its potential GDP . Notice that, in particular, there has been plenty of job creation in the labor market and so maybe unemployment is now at its natural rate, as the labor market tightens.

Just a day later, however, the Bank of Japan announced that it would not, as expected, change its monetary policy, even though the economy would benefit from further stimulus.  The Japanese economy seems to be unable to get out of the deflationary spiral that is dragging down real GDP. The consumer price index dropped again by 0.3% in March and consumption remains weak. In addition, the earthquakes in Kyushu led to factory shutdowns in other parts of Japan (eg Toyota), which may pull down GDP growth further.

Nonetheless the Japanese central bank will keep its negative interest policy and will continue with its massive bond purchase scheme  (which is basically the same as “printing money”). It is probably hoping that the proposed interest rate rise in the USA will attract savers to put their funds there (an inflow on the financial account of the USA BOP). The flows of financial/portfolio “investment” would cause the dollar to appreciate and the yen to depreciate, lowering Japanese export prices and boosting the net exports component of aggregate demand. Thus Japan could benefit from foreign exchange movements without being accused of deliberately trying to depreciate or undervalue the yen.

 

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