Repercussions of BOJ's Quantitative and Qualitative Easing

◆The relationship between inflation expectations and interest rates has come under the spotlight. Some argue that the Bank of Japan (BOJ) has set a pair of inconsistent goals, namely a lower nominal interest rate and a higher expected inflation rate, goals which cannot be pursued simultaneously. Others believe BOJ’s policy of aiming for a higher expected inflation rate will lower real interest rates, thus spurring the economy.

◆Reviewing the trends of nominal/real interest rates and the expected inflation rate from the beginning of 2013 in Japan, a higher expected inflation rate resulted in a lower real interest rate on one occasion but a higher nominal interest rate on another. Currently, no stable relationships are observed among nominal interest rate, real interest rate, and expected inflation rate.

◆Looking at real interest rate trends from a global perspective gives a different picture. Empirically and theoretically, real interest rates tend to converge to equilibrium over the long term among advanced nations. Japan’s real interest rate has currently converged to those in the US and UK.

◆When there is plenty of room for real interest rates to decline, a higher expected inflation rate will cause them to fall. In contrast, when Japan’s real interest rate moves in line with those in major economies, a higher expected inflation rate will push up the nominal interest rate.

◆A tapering of QE3 in the US could exert upward pressure on real interest rates in advanced nations. In conclusion, if the expected inflation rate moves upward in Japan, the nominal interest rate is likely to begin to rise in Japan.