 short-term policy interest rate. This episode highlights the importance of bringing about an increase in the so-called neutral interest rate — that is, the nominal interest rate level that is neutral to economic activity — by anchoring inflation expectations at about 2 percent and of securing the ability of monetary policy to respond.
I took office as Governor of the Bank of Japan in March 2013 and immediately introduced a monetary policy regime — quantitative and qualitative monetary easing (QQE) — that is quite different from past regimes. QQE consists of two pillars: (1) directly working on people’s expectations through a price stability target of 2 percent and a strong and clear commitment to doing whatever it takes to achieve this, and (2) directly encouraging a decline in long-term interest rates through large-scale purchases of long-term Japanese government bonds (JGBs). If inflation expectations rise as a result of the former and nominal long-term interest rates fall as a result of the latter, this will push real interest rates to levels below the natural rate of interest even in the face of the zero lower bound.
The policy in which a central bank lowers interest rates and deposit ratios to make credit more easily available. This makes borrowing easier for businesses, which stimulates investment and expansion of operations. The immediate result of monetary easing is generally a boost in stock prices. In the medium term, it promotes economic growth. However, if this policy remains for too long, it can lead to a situation in which there is a glut of currency or too many dollars chasing too few goods and services, leading to inflation. For this reason, most central banks alternate between policies of monetary easing and monetary tightening to encourage growth while keeping inflation under control.
In additional steps, the Bank of Japan in January 2016 introduced a negative interest rate policy in order to address the strong headwinds caused by turbulence in global financial markets. The negative interest rate policy aims at exerting further downward pressure on interest rates across the entire yield curve by pushing down the short end of the yield curve, in combination with large-scale purchases of JGBs. Thereafter, in September 2016, the Bank conducted a comprehensive assessment on developments in economic activity and prices as well as policy effects since the introduction of QQE; based on the findings, the Bank introduced yield curve control, which focuses on long-term interest rates in addition to short-term interest rates as the operating target. However, the basic approach of lowering nominal interest rates across the entire yield curve and lowering real interest rates by raising inflation expectations has remained unchanged.
In modern central banking, QQE is classified as unconventional monetary policy, but from a somewhat longer-term perspective, it can be said to be a contemporary application of Hawtrey’s theory on the importance of guiding expectations and Keynes’ theory that monetary easing can be conducted through the purchase of long-term government bonds. An old East Asian proverb –“visiting old, learn new”– says that one can derive new understanding from learning the lessons of the past, and I think this is particularly apt with regard to the intellectual journey leading up to QQE.
In practice, QQE has produced its intended effects. Inflation expectations climbed notably after the introduction of QQE. This demonstrates that a strong determination by the central bank pushes up people’s forward-looking inflation expectations. In addition, the large-scale purchases of JGBsas part of QQE have exerted downward pressure on nominal interest rates across the entire yield curve. As a result, the Bank of Japan has succeeded in reducing real interest rates to levels well below the natural rate of interest for the first time in its two-decade long battle with the zero lower bound on the short-term policy interest rate (Chart 7).
These monetary easing effects have stimulated economic activity both in the corporat