Considering monetary policy - Nomura

Analysts at Nomura explained that failure to achieve BOJ's inflation target and options open to monetary policymakers.

Key Quotes:

"We have considered inflation over the longer term.

We now consider monetary policy. 

Recently there has been much heated discussion of helicopter money. We attribute this to a sharp increase in the number of those who question the BOJ's current monetary policy. In January of this year the BOJ decided to adopt a negative interest rate policy. However, we see no convincing evidence that this has helped to boost inflation. 

Despite this, the BOJ has shown no sign of easing its commitment to achieving its 2% inflation target as soon as possible. In that case, it would make sense to pursue a more aggressive monetary policy and to try using helicopter money. If, as we have argued, declining growth expectations as a result of Japan's declining population are the fundamental reason why inflation has failed to take off, this is a perfectly natural development. Helicopter money is a powerful tool for boosting inflation. For example, if a central bank is prepared to finance fiscal expansion in the form of public investment and gift vouchers, demand can be stimulated and inflation boosted regardless of growth expectations. 

Helicopter money also has the potential to boost consumer spending via its impact on household growth expectations by writing off government debt. It is generally believed that the BOJ will eventually sell the massive amount of JGBs it has been buying in the market. When that happens, it will be the Japanese people who have to bear the cost of redeeming those bonds, probably by paying higher taxes or social security premiums. However, the BOJ could opt not to sell those bonds. 

For example, it could convert bonds that were approaching redemption to perpetual bonds and take the national debt onto its own balance sheet. This would have the effect of retiring those bonds and freeing the Japanese people from any obligation to redeem them. Because this would reduce the need to raise taxes or social security premiums, the prospects for household income would improve and the resulting increase in consumer spending might boost inflation. 

Of course, the use of helicopter money has been a taboo subject because of the risk that it could get out of control and inflation rise above the BOJ's target. We also think that the BOJ and MOF are basically opposed to this idea and that helicopter money is unlikely to be used any time soon. 

However, if inflation continues to fall short of the BOJ's target we cannot rule out the possibility that pressure could mount for the BOJ to adopt radical policies such as the use of helicopter money. 

This would be increasingly likely if the Japanese economy went into recession and deflation threatened to reemerge as a result of external economic conditions. In that situation, the authorities could make their opposition to using helicopter money clear by easing their commitment to the BOJ's 2% inflation target (eg, by making it a longer-term target). However, this would not be an easy option because it would risk further yen appreciation. Either way, the longer inflation remains low, the greater the likelihood that the BOJ will be obliged to decide either to adopt a more radical monetary policy (including the use of helicopter money) or to ease its commitment to its inflation target."