The law of unintended consequences has reared its head yet again. The Bank of Japan (BoJ) has a set target of purchasing $80 trillion yen (AUD$1 trillion) worth of Japanese Government Bonds (JGBs) per year. In buying JGBs from investors in the secondary market, the central bank hopes two things will happen. First, investors will have more cash and thus are more likely to spend it on goods and services in the Japanese economy. Second, the BoJ’s purchases keep the price of JGBs high and thus the yield low, thereby providing an incentive for investors to spend part of their cash holdings rather than save/invest it. The hoped-for result is a moderate level of inflation which is what central banks generally like.
However, such a plan becomes unstuck when holders of JGB’s don’t play ball and sell. Apparently, this has been happening and trading in some JGBs has been observed as haphazard. As the BoJ ends up owning an ever-increasing percentage of the total JGBs on issuer, there are fewer and fewer other holders in a position to sell them.
An IMF working paper by Serkan Arslanalp and Dennis Botman addressed this issue. “There is a minimum level of demand for JGBs from banks, pension funds, and insurance companies due to collateral needs, asset allocation targets, and asset-liability management (ALM) requirements…This raises the question how long the current unprecedented pace of JGB purchases, equivalent to about 1 percent of GDP every month, or near 10 percent of the market on an annual basis, can continue before the BoJ runs into speed limits.”
In response to this upcoming roadblock for BoJ monetary policy, Jefferies Group strategist Sean Darby proposed the BoJ consolidate some of its existing holdings into perpetual zero coupon bonds. He thinks the BoJ will indicate its intention to do so after a meeting later this month and says its decision to implement a negative official interest rate in January was part of its plan to push yields at the longer end of the curve lower in preparation for the issue of such bonds. They would cost nothing to service, never have to be repaid and the Japanese Government could continue to issue JGBs to finance spending increases or tax cuts, which the BoJ could then buy as part of its bond purchase programme.