Roles Reversed: Bank of Japan Lectures Bernanke
A speech from BOJ Deputy Governor Kikuo Iwata last night:
More recently in the United States, nominal rates went up, inflation expectations came down, and the expected real rates picked up after market participants started forming a view that the Fed would start tapering the pace of its asset purchases in light of Chairman Bernanke’s testimony on May 22, while in reality this was meant to slow the pace of increase in excess reserves. By contrast, the FOMC’s decision to continue with its quantitative easing on September 18 led to a decline in nominal rates, a rise in inflation expectations, and a decline in the expected real rates (Chart 23).
How beautifully ironic that the BOJ board is able to produce a critique of Bernanke’s tight money. Iwata continues:
What should we make of these episodes? In my view, they owe much to the fact that market participants make judgments on the monetary policy regime after they see changes in the monetary base and the excess reserves, and then form projections for the money stock, the future course of interest rates, and projections for prices.
What matters to interest rates and inflation expectations is the monetary policy regime of a central bank and market participants’ views on the prospects for the money stock based on such a regime. The current level of money stock is irrelevant. It is in this sense that the simple “quantity theory of money,” in which there is a one-to-one relationship between the current money stock and prices, does not hold in practice. Nonetheless, there is a close relationship between the projected future course of the money stock and inflation expectations, and the present rate of inflation is determined based on inflation expectations formed in that way.