Loose thinking

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: The Bank of Japan (BoJ) pioneered the process known as quantitative easing (QE) in 2001-06, when it massively boosted the reserves that commercial banks held at the central bank. Its verdict on how well QE worked then ought to interest policymakers today. It will also discomfort them. For all that it propped up Japan’s creaking banking system, QE did not really improve the economy nor end the country’s deflationary mindset (see chart).

That much was acknowledged by Masaaki Shirakawa, the bank’s governor, during a speech in Shanghai this summer. In a forthcoming paper*, Shigenori Shiratsuka, one of the BoJ’s senior economists, re-examines Japan’s experience of QE in light of the extraordinary monetary-policy measures taken by central banks since last year (the BoJ among them). His research finds many common elements between the BoJ’s policy responses from the late 1990s onwards and unconventional measures currently being taken around the world. It also issues warnings about the limitations and potential side-effects of QE.

Shiratsuka’s arguments vary, at least in part, from those of people like Ben Bernanke, the chairman of America’s Federal Reserve, who says there are conceptual differences between Japan’s previous form of QE and the “credit easing” that the Fed is currently engaged in. In January Bernanke said that the Fed’s approach was focused on buying up loans and securities—that is, on the asset side of its balance-sheet. By contrast the BoJ’s approach was focused on the quantity of bank reserves held at the central bank—or the liability side of its balance-sheet.

Shiratsuka, however, sees “striking similarities” between these approaches because the asset and liability sides of central banks’ balance-sheets interact so closely. On the asset side, QE works through the buying up of private-sector and government instruments. When private markets seize up, central banks step in. But this activity is financed by an increase in commercial-bank reserves, or liabilities, created by the central bank. These reserves provide a buffer for banks when liquidity dries up in financial markets. Although there may be differences in the size and composition of central-bank balance-sheets, these depend on the state of the economy, particularly the financial system, rather than the mechanics of QE.