Japanese monetary trends continue to suggest remarkably little impact from the country’s QE experiment.
 
Annual growth of broad money M3 stood at 2.1% when the Bank of Japan (BoJ) launched QE in October 2010; it was 2.5% in March 2013, when the programme was expanded significantly; it was 2.5% also in July this year.

As discussed in a post in June, the BoJ’s injection of money via its purchases of Japanese government bonds (JGBs) has been neutralised by an opposing shift by banks, who were expanding their lending to the government in 2010 but have been cutting it back more recently – see the “monetary counterparts” chart below. A key reason for this change is that QE has raised banks’ reserves at the BoJ, allowing them to reduce their JGB holdings while still meeting their liquidity targets. The BoJ and banks have, in effect, swapped JGBs and reserves, with no impact on the supply of money to households and firms.

There has been an additional drag on M3 growth recently from a reduction in banks’ net foreign asset position, following expansion in late 2012 and 2013. This, in turn, reflects the balance of payments basic balance moving from surplus to deficit – second chart. The main driver of this shift has been an increase in portfolio outflows, probably related to QE.
 
Japan’s experience supports the view here that QE has little impact on monetary trends under normal circumstances. Extending / expanding the BoJ’s bond-buying operation would be unlikely to make much difference. Banks’ outstanding lending to the government remains substantial – equivalent to 25% of M3 – and they would probably sell more JGBs to offset the additional reserves boost from higher BoJ purchases.

QE might have a larger monetary impact if the BoJ bought equities rather than bonds. Banks’ equity holdings are much smaller – less than 2% of M3. They would, however, still have an incentive to offload JGBs to counter reserves expansion. The BoJ could be constrained from switching QE away from bonds because of the smaller size of the equity market – the current ¥50 trillion annual pace of JGB buying is equivalent to 11% of stock market capitalisation.

Additional BoJ easing, in whatever form, could encourage further portfolio outflows, implying a negative external effect on money growth.

Rather than further monetary experimentation, Japan needs action on mooted “third arrow” structural reforms to boost supply-side economic performance. By enhancing confidence in medium-term prospects, such reforms could cause a rise in the velocity of circulation of the existing money stock while encouraging private sector credit growth – a firmer basis than QE for stronger M3 expansion.