Friday, October 31, 2014

The Bank of Japan’s Quantitative Easing: An Unnatural Imbalance

On October 31, 2014, the Bank of Japan made public its policy of buying larger amounts of government debt—80 trillion yen ($734 billion) a year—so as to stimulate the economy.[1] The Nikkei 225-stock index average rose almost 5 percent that day, while the yen fell to its lowest level against the dollar since the preceding month. In effect, investors and analysts were factoring in the likely stimulatory impact on the economy and the inflationary implication of more yen relative even to the expanded output, respectively. Put another way, the lower yen suggests that any strengthening of the currency from higher economic output would be more than countered by the weakening impact of inflation. Interestingly, not even the likely boost to exports from the cheaper yen was expected by the market participants to give the stimulus the edge in pushing the currency higher rather than lower.
I submit that the central bank’s strategy is suboptimal in terms of the mission to stabilize the currency on account of the risk of an inflationary spiral. The imprudence, or imbalance in favor of stimulus, stems from another imbalance wherein exaggerated fears of deflation are allowed to eclipse the common-sense notion that periods of deflation naturally go alone with there being periods of inflation. The problematic mentality, I contend, can be understood in terms of a wave function wherein only the half of each wave above the base line are permitted. Such a policy goes against the nature of a wave function to spend as much time below the line as above it. In monetary terms, price stability is thwarted in favor of an inflationary bias.
I suspect the root of the problem involves a failure to distinguish between moderate, or cyclical deflation and the severe, ruinous kind. The lack of balance involved in resolutely shutting off even low deflation after years of inflation can resonate into an economy being out of balance. That is to say, the imbalance can expand like a ripple in a pond—a ripple being of course a natural wave function of ups and downs rather than only ups. Perhaps applying principles of natural science to macroeconomics might help central bankers in their task to maintain price stability.

[1] Jonathan Soble, “Japan’s Central Bank Unexpectedly Moves to Stimulate Economy,” The New York Times, October 31, 2014.