BOJ’s JGB Purchasing Limits to be Reached in Summer … (eng).pdfmonetary policy the BOJ introduced after Japan’s nominal interest rate reached its Zero Lower Bound (ZLB) in the

November 28, 2016

<The Effects of BOJ’s Quantitative and Qualitative Monetary Easing with Yield Curve Control>

BOJ’s JGB Purchasing Limits to be Reached in Summer 2017

— Is the Bank carrying out Fiscal Policy?

JCER Financial Research Team1

Kazumasa IWATA (President of JCER)Ikuko FUEDA-SAMIKAWA (Principal Economist)

Eriko TAKAHASHI (Senior Economist)

On September 21, 2016, the Bank of Japan announced a new framework for strengthening monetary

easing: “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control (YCC)”, replacing

the previously introduced policy, “QQE with a Negative Interest Rate”. It is the sixth unconventional

monetary policy the BOJ introduced after Japan’s nominal interest rate reached its Zero Lower Bound

(ZLB) in the late 1990s. Although the Bank strongly declared that “Japan's economy is no longer in

deflation” in their Comprehensive Assessment, published in September 2016, it has not yet succeeded in

attaining its inflation target of 2%. The latest figure shows that the consumer price index (CPI) for all items

less fresh food was negative 0.4 for October 2016, declining for eight consecutive months. Japan is now

under the imperative risk of slipping back into deflation.

To tackle the long persisting deflation, the BOJ has been purchasing unprecedentedly massive amounts

of government bonds that in effect increased its balance sheet, exceeding 90% of Japan’s nominal gross

domestic product (GDP). The fabled monetary “bazooka” fired by Governor Haruhiko Kuroda in April

2013 appeared successful at first, raising inflation expectations. However, the BOJ had been running out of

willing sellers of Japanese Government Bonds (JGBs) and was forced to shift its numerical target from

quantity to the policy rate. What is the real matter behind this?

In this report, we begin by looking through the BOJ’s various unconventional monetary policies. The

Bank has been likened to a “whale in the pond”, by becoming the biggest player in not only the JGB

market but also in Exchange-Traded Fund (ETF) market; its influence over their price formation is

criticized as being government-controlled. Is the bank carrying out fiscal policy? The soundness of the

BOJ’s balance sheet is becoming vulnerable, addressing the issue of central bank’s independence. With

regard to corporate governance, the fact that the Bank has become the largest stakeholder for a number of

private institutions via its large-scale ETF purchases can be seen as helping so-called “zombie companies”

to survive. This may drag Japan’s economy into secular stagnation.

1 Research Director: Ikuko SAMIKAWA (Principal Economist), Lead Researcher: Eriko TAKAHASHI (Senior Economist), Trainee Economists: Yasuhisa HAKUBI (Aflac), Asuka NOMURA (Japan Housing Finance Agency), Tetsu SAITO (Joyo Bank), Midori SHIRAISHI (Japan Finance Corporation).

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http://www.jcer.or.jp/

Japan Center for Economic Research Financial Research Team November 28, 2016

1. BOJ’s Shift from Quantity to the Policy Rate

1-1. Sixth Stage of BOJ’s Unconventional Monetary Policies

The BOJ has been taking a number of unconventional monetary policies since the late 1990s

(Fig.1-1). The Bank introduced negative interest rate policy at the end of January 2016, and in

September, it began controlling the long-term interest rate. The current monetary framework is named

“QQE with yield curve control”.

Back in April 2013, BOJ entered a new phase of monetary easing in terms of both quantity and

quality, the so-called QQE. They announced that it will “achieve the price stability target of 2% at the

earliest possible time, with a time horizon of about two years”. However, the headline inflation rate

has not yet reached the target level. In fact, the CPI core inflation rate -- the YoY rate of change in the

consumer price index (CPI) for all items less fresh food --has turned to be negative again.

What are the risks and effects of Japan’s QQE, including Negative Interest Rate Policy (NIRP)

and YCC? Will the monetary base target be sustainable? What happens if the Bank continues to

purchase massive amount of JGBs?

Fig.1-1 BOJ’s Unconventional Monetary Policies

Note: Monetary policies are sorted in order of announcement. Source: BOJ

【BOJ Governor &Term served】

(1) Zero Interest Rate Policy Masaru Hayami　　　⇒Lowering Policy Rate Feb 99～Aug 00

(2) Quantitative Easing Policy Toshihiko Fukui　　　⇒Quantitative Expansion Mar 01～Mar 06

Mar 03～Mar 08

Masaaki Shirakawa

(3) Comprehensive Easing Policy Apr 08～Mar 13　　　⇒Purchasing Various Assets Oct 10～Apr 13

(4) Quantitative and Qualitative Easing Policy Haruhiko Kuroda　　　⇒Changing Expectations Apr 13～Jan 16

Apr 13～Present(5) Quantitative and Qualitative Monetary Easing with a Negative interest Rate　　　⇒Introduction of NIRP Jan 16～Sept 16(6) Quantitative and Qualitative Monetary Easing with Yield Curve Control　　　⇒Introduction of Yield Curve Control Sept 16～Present

【Unconventional Monetary Policies】

Mar 98～Mar 03

In September 2016, the BOJ introduced a new policy framework “QQE with Yield Curve Control

(YCC)” . It is Japan’s sixth unconventional monetary policy under which the BOJ started to control the

long-term interest rate, by fixing 10-year government bond yield at zero percent. Although the policy

seems to have been successful in controlling the yield curve, Japan is currently facing the risk of slipping

back into deflation.

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Under the leadership of Governor Haruhiko Kuroda, the BOJ introduced QQE, conducting

large-scale monetary easing in order to overcome Japan’s 15-year deflation, and to achieve its 2%

price stability target (Fig.1-2). As a result, corporate profits, measured by the ratio of current profits to

sales, have been at a record-high level, while the unemployment rate has declined to as low as 3%.

However, on the price front, although the BOJ declared in the Comprehensive Assessment

published in September 2016 that Japan’s economy was no longer in deflation,--commonly defined as

a sustained decline in prices-- the price stability target of 2% has yet to be achieved.

Consequently, the BOJ introduced the new monetary policy framework "QQE with Yield Curve

Control (YCC)", which consists of two major components: (1) YCC which aims to influence the long

end as well as the short end of the yield curve and (2) Inflation-overshooting Commitment under

which the Bank will continue expanding the monetary base until the core CPI inflation rate exceeds

2% and stays above the target in a stable manner.

Fig.1-2 Change in Monetary Policy under Governor Kuroda

Note: Monetary policies are sorted in order of announcement. Source: BOJ

Since the introduction of QQE in April 2013, the BOJ had been purchasing JGBs of around 7

trillion yen (USD 63.6 billion) every month, and the amount was raised to around 9 trillion yen (USD

81.8 billion) every month after the expansion of QQE in October 2014.

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The average remaining maturity of the Bank’s JGB purchases was extended from about 7 years to

around 7-12 years at the end of last year (Fig.1-3). However, the guideline for average remaining

maturity was abolished with the introduction of QQE with YCC in September 2016.

Fig.1-3 BOJ's JGB Purchases

Note: 1. Face value basis. Including JGBs purchased through the asset purchase fund.

2. Long-term JGBs are JGBs excluding treasury discount bills, and there is no distinction in terms of time period left to reach maturity (remaining maturity).

Source: BOJ, Issue-by-Issue for JGBs; MOF, Buyback Auction Results; Estimated by JCER Financial Research team

The Bank’s JGB holdings have been increasing rapidly. The outstanding amount of long-term

JGBs held by the BOJ came to almost 350 trillion yen (USD 3.2 trillion) at the end of October 2016.

In the past three and half years under QQE, both monetary base and the outstanding amounts of JGBs

have more than tripled.

The average remaining maturity period of JGBs that the Bank holds has lengthened rapidly since

the introduction of QQE (Fig.1-4). The remaining period was extended to around 7.4 years at the end

of October 2016. Under the past QE and Comprehensive Easing policies, although the outstanding

amount of long-term JGBs increased, the remaining maturity period shortened because the BOJ

bought shorter-term JGBs. This is why the BOJ is said to have entered a new phase of monetary

easing in April 2013.

The remaining maturity of JGBs held by the Bank indicates that it will take over seven years for

redemption. This will make it hard for the BOJ to reduce its own balance sheet without selling JGBs

in the Bank’s “exit” phase.

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Expansion of QQE

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QQE

（Monthly）

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Fig.1-4 BOJ’s JGB Holdings

Note: 1. Face value basis. Including JGBs purchased through the asset purchase fund.

2. Long-term JGBs are JGBs excluding treasury discount bills, and there is no distinction in terms of time period left to reach maturity (remaining maturity).

Source: BOJ, Issue-by-Issue for JGBs; MOF, Buyback Auction Results; Calculated by JCER Financial Research Team

At the end of September 2016, the total asset of BOJ was 463 trillion yen (USD 4.2 trillion),

which accounted for over 90% of nominal GDP, far above the levels of any other major central banks

in advanced economies (Fig.1-5); QQE is truly an unprecedented measure of monetary easing in our

modern history.

Fig.1-5 Total Assets of BOJ exceeds 90% of Nominal GDP

Source: BOJ, BEA, FRB, Bloomberg

In January 2016, the BOJ announced the introduction of NIRP, and started to operate a so-called

“Three-Tier System”, where the BOJ current account balance is divided into (1) Basic Balance: a

positive interest rate of 0.1% will be applied, (2) Macro Add-on Balance: zero interest rate will be

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【Total Assets of Central Banks】(% of nominal GDP)

(Quarterly)

16:3

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applied, and (3) Policy-Rate Balance: a negative interest rate of -0.1% will be applied (Fig.1-6 left).

Therefore, a negative interest rate is only applied to a marginal increase in the current account balance

but it has its full impact on the market rate.

Under the new system, some financial institutions hold current account balances in the tier to

which the negative interest rate is applied, while other institutions have unused allowances in tiers to

which the zero or positive interest rate is applied. Financial institutions that have unused allowances in

tiers to which the zero or positive interest rate is applied can raise funds in the interbank money

market from other institutions at a rate between negative 0.1% and 0%, so this is profitable for both

sides. Other financial institutions that hold balances to which the negative interest rate is applied can

offer short-term funds at a rate higher than negative 0.1%, in the market. Fig.1-6 (right) shows that

after these arbitrage transactions took place, the net amount of negative-rate balances for

September-October 2016 totaled 15 trillion yen (USD136.4 billion) for those financial institutions

subject to the reserve requirement, such as Japan Post Bank.

Fig.1-6 Three-Tier System and the Current Account Balance to which Negative Interest Rate applies

Note: 1. Others A: Other institutions subject to the reserve requirement (e.g. Japan Post Bank). 2. Others B: Other institutions holding current accounts with the BOJ.

Source: BOJ

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After the introduction of NIRP in January 2016, activities in the call market stagnated (Fig. 1-7-1).

Particularly, in the collateralized call market, the amount outstanding fell sharply (Fig.1-7-2).

Fig.1-7-1 Amount Outstanding in the Call Money Market

Note: Daily data up to and including Nov 25, 2016. Source: NEEDS-FinancialQUEST

Fig.1-7-2 Amount Outstanding in the Call Money Market

Source: BOJ, Amount Outstanding in the Call Money Market

1-2. Increasing Risk of falling back into Deflation

QQE started in April 2013, with the target of achieving 2% YoY change in CPI. From late 2013 to

mid-14, it seemed things were on track to achieving the BOJ’s target (Fig.1-8). However, prices

started slipping from mid-14 onward, due to the decline in oil prices, as well as the slowdown of

commodity exporting and emerging economies especially China. Prices have been continuing to fall

in 2016. The core CPI inflation rate for September 2016 was negative 0.5%, which was the lowest

since March 2011, when the Great East Japan Earthquake occurred. The latest figure for October was

negative 0.4%, recording a negative YoY rate for eight months straight.

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Announcement of QQEwith Yield Curve Control

(Sept 21, 2016)

Announcement/Introduction ofNIRP (Jan 29, 2016/Feb 16, 2016)

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Borrower(Tril. yen)【Uncollateralized Call Market】【Collateralized Call Market】

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Fig.1-8 Consumer Price Index (CPI)

Source: BOJ, NEEDS-FinancialQUEST

The Nikkei CPI Now index is a price indicator based on daily scanner data collected from over

800 supermarkets. Prices soared from 2015 onward, reaching 1.9% YoY in February 2016, just short

of 2% (Fig.1-9 left). However, the YoY rate of change quickly slowed, and slipped into negative

territory from August onward.

The SRI-Hitotsubashi University Consumer Purchase Index, a weekly price index based on

Point-of-Sale (POS) data of 4,000 stores, shows similar trends (Fig.1-9 right).

Fig.1-9 Daily Price Indices

Note: Daily data up to and including Nov 25, 2016, and weekly data up to and including Nov 14, 2016. Source: Nowcast, Hitotsubashi University

With the introduction of QQE with YCC in September this year, the BOJ abandoned its 2 year

timeframe for achieving 2% inflation target. It has become a medium-term target with no specific time

frame. According to its latest October Outlook Report, the BOJ pushed back the timing of achieving

its 2% price target from “during FY2017 (ending March 2018) to “around FY2018” (Fig.1-10).

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(YoY, %)

(Monthly)

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(YoY, %)

(Weekly)

16/11

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Fig.1-10 BOJ postpones the Target Date of reaching the Price Stability Target

Note: The horizontal axis indicates the release date of the Outlook Report. Source: BOJ, Outlook for Economic Activity and Prices

The Fig.1-11 shows different measures of inflation expectations at four different points in time -

A: 2013Q1 before the introduction of QQE, B: 2014Q3 before the expansion of QQE, C: 2015Q4

before the introduction of NIRP, and D: 2016Q2 after the introduction of NIRP.

Comparing the change in inflation expectations from pre-QQE to Post-NIRP, we find that

expectations rose in about half of the indicators. However, comparing the changes before and after the

introduction of NIRP, it is clear that the policy hurt inflation expectations, causing them to weaken.

Fig.1-11 Inflation Expectations

Note: 1. Daily and monthly data have been converted to quarterly data. 2. ESP forecasts exclude consumption tax-hike effects. Dec 2012, June 2014, Dec 2015 and June 2016 values are used for the periods A through D. 3. Consensus forecasts: Oct 2012, April 2014, Oct 2015 and April 2016 values are used for the periods A through D. 4. Tankan: All industries/ all enterprises data, average. 5. Consumer confidence survey: All households’ data, weighted average. 6. BOJ opinion survey: median data. Source: JCER, QUICK, Bloomberg, BOJ, Cabinet Office

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【FY18 Inflation Forecast】(YoY,%)

(Quarterly)

(YoY,%)

(%, %pt)

A. 2013Q1(Pre-QQE)

B. 2014Q3(Pre-QQEExpansion)

C. 2015Q4(Pre-NIRP)

D. 2016Q2(Post-NIRP)

Difference(D - A)

Difference(D - C)

In 1 year -0.5 0.6 0.5 0.5 +1.0 +0.0In 2-6 years 0.7 1.4 1.3 1.0 +0.3 -0.3 In 7-11 years 1.0 1.5 1.4 1.0 +0.0 -0.4 In the next year 0.1 2.3 0.5 0.3 +0.2 -0.3 In the next 2 years 0.6 2.1 1.0 0.6 +0.0 -0.4 In the next 10 years 1.1 1.6 1.1 0.9 -0.2 -0.2

0.3 1.6 1.3 1.1 +0.8 -0.2 ― 1.1 0.7 0.3 ― ―

0.8 1.1 0.7 0.1 -0.7 -0.6 In 1 year ― 1.5 1.0 0.7 ― ―In 3 years ― 1.6 1.3 1.1 ― ―In 5 years ― 1.7 1.4 1.1 ― ―

1.9 2.9 2.4 2.1 +0.2 -0.3 In the past year 0.2 5.0 4.3 3.0 +2.8 -1.3 In the next year 3.0 3.0 3.0 2.0 -1.0 -1.0 In the next 5 years 2.0 2.0 2.0 2.0 +0.0 +0.0

BEI, inflation indexed bonds (10 years)Inflation Swap Rate (5 year/ 5 year)

Tankan(Inflation

expectations)Consumer Confidence Survey (In 1 year)

BOJ OpinionSurvey

Consensus Forecasts (in 5 years)

ESPForecasts

QUICKSurvey

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1-3. QQE with Yield Curve Control

Yield Curve Control

The “Yield Curve Control (YCC)” aims to influence the long end as well as the short end of the

yield curve. The BOJ will seek to maintain the long-term interest rate at the present 0% level or

thereabouts. When the long-term interest rate rises over 0%, the Bank will purchase JGBs so that

10-year JGB yields will remain more or less at the current level (around 0%). This means the BOJ has

strengthened its commitment to maintain the 0% long-term rate. BOJ Policy Board Member Yutaka

Harada stated that the Bank would tolerate a declining long-term interest rate but not an increasing

one.

The measure looks similar to the long-term interest rate pegging system taken by the US Federal

Reserve Board until 1951, although capital movements were severely restricted during wartime and

under the Bretton Woods regime. There is another issue of whether the central bank can control

long-term interest rates, which consist of expected short-term interest rate and risk premiums

including term premium. In addition, JGBs with a wide range of maturities will continue to be eligible

for purchase, while the guideline for average remaining maturity of the Bank's JGB purchases has

been abolished.

After the beginning of NIRP in February this year, JGB yields fell sharply (Fig.1-12). They further

declined in July after Britain voted out of the EU; even 20-year JGB yields turned negative for the

first time, falling as low as negative 0.005% .

Fig.1-12 JGB Yield turned Negative in early 2016

Note: Daily data up to and including Nov 25, 2016. Source: Bloomberg

However, after the US Presidential election, Japan’s long-term interest slightly increased. The

market strengthened expectations for a December rate rise by the Fed, and the JGB yield curve turned

anti-clockwise after the introduction of QQE with YCC (Fig.1-13). On November 17, the BOJ

announced for the first time that it would buy as many JGBs as the market wanted to sell with one to

five years left to maturity at a fixed price, asserting its new cap on the yield curve. It did not bid for

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10-year bonds, where it has capped the yield at 0%.

Fig.1-13 JGB Yield Curve turned anti-clockwise after the Start of QQE with YCC

Note: Data for Nov 2016 is the average of data from November 1, 2016 through November 25, 2016. Source: Bloomberg

Inflation-Overshooting Commitment

Under the “inflation-overshooting commitment,” the BOJ will expand liquidity with the aim of

achieving a stable, observed inflation rate greater than 2% (Fig.1-14). The inflation rate implied here

is core CPI (all items less fresh food). As we see in Fig. 1-8, core CPI has been in negative territory

for eight months straight, which implies that it will take time for the BOJ to reach the exit phase of the

current unprecedented easing policy.

Fig.1-14 Inflation-Overshooting Commitment

Source: BOJ “Economic Activity, Prices, and Monetary Policy in Japan (Oct 12, 2016 Speech at a Meeting with Business Leaders in Nagano)” (Yutaka Harada, BOJ Policy Board Member)

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2. Government-controlled JGB and ETF Markets

2-1. BOJ’s “Whale in the Pond” Issue 1 : JGB Market

Three and a half years have already passed since the introduction of Quantitative and

Qualitative Monetary Easing (QQE) in April 2013. Since the start of QQE, the BOJ has purchased

large quantities of government bonds from the market on a monthly basis. Fig. 2-1 shows the flow of

JGB net buyers and sellers. Under QQE, net JGB purchases by the BOJ have more than doubled,

totaling 359.6 trillion yen (USD 3.3 trillion for 2014Q2-2016Q3). The JGB market remains stable, but

if such purchases by the Bank were regarded as monetizing government debt, the JGB market may

start destabilizing, raising long-term interest rates. This could not only offset monetary easing effects,

but also have a negative impact on Japan's financial system.

The BOJ has repeatedly stated that JGB purchases under QQE are executed for the purpose of

conducting monetary policy and not for financing fiscal deficits. However, to avoid any skepticism

regarding this issue, it is vital for the government to clearly show the future course of fiscal

consolidation and steadily make progress to reform the fiscal structure.

Fig. 2-1 JGB Net Buyers and Sellers

Note: Data excludes T-Bills. Source: JSDA

In addition to the BOJ, overseas investors have been increasing their purchases of JGBs and

Treasury Bills (Fig. 2-2). Although both short-term and long-term interest rates have been negative in

Japan, the dollar-yen swap rates have also been negative, which helps overseas investors to earn extra

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(Trillion yen)

(Quarterly)

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Since the BOJ has been the largest buyer of JGBs, the market is criticized as being

“government-controlled”. Those JGBs with relatively higher coupon rates held by the Bank have

gradually reached their maturities and the average coupon rate is currently 0.77%, having declined by

0.34 percentage points since the start of QQE. The BOJ is ironically called the “whale in the pond” in

the ETF market, not to mention the JGB market. This increases the risk of the BOJ incurring losses if a

sharp decline in stock prices occurs.

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interest. The amount of T-Bill purchase by overseas investors has rapidly been increasing under

negative interest rates.

Fig. 2-2 Dollar-yen Swap Rate and Overseas Investors

Source: JSDA, Bloomberg

How have the BOJ holdings of government bonds changed as a result of the BOJ trade? In Fig.

2-3, the vertical axis charts the balance of government bonds held by the BOJ, while the horizontal

axis shows the nominal coupon for government bonds. At the end of March 2013 (before the start of

QQE), 20-year bonds with coupon rates of 4.0% or higher accounted for approximately 1.1 trillion

yen (USD 10 billion), but by January 2016, approximately three years later, the balance was zero as

the redemption period edged closer. As recently as the end of October 2016, only 740 billion yen

(USD 6.7 billion) worth of 20-year bonds with a yield of 3% or higher remained. The high coupon

government bonds issued in the past are gradually coming up for redemption. At the end of March

2013, the weighted average interest [(balance by issue x nominal coupon) / total balance] for

government bonds held by the BOJ was 1.11%, but by the end of October 2016 it had declined to

0.77%, down by 0.34 percentage points.

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16/09

(bps)（Trillion yen）

(Monthly)

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Fig. 2-3 Nominal Coupon Rate and Amount of JGBs held by BOJ

Source: BOJ, MOF

The S&P/JPX Japanese Government Bond VIX Index (Fig. 2-4 top left), which indicates the

expected volatility of futures prices for long-term government bonds, rallied in February 2016 as a

result of the negative interest rate policy. Later, the trend turned upward again for a time, but the rate

dropped below 2.0 points when QQE with YCC was released in late September 2016. The bid-ask

spread (Fig. 2-4 top right), which is the difference between the price (bid) proposed by the buyer of

government bonds and the seller’s price (ask), is holding steady in the near term. The price/trading

volume ratio (Fig. 2-4 bottom left), which is the ratio of price change to trading volume, rose sharply

when the BOJ decided against any additional easing at the Monetary Policy Meeting at the end of July

2016, and announced a comprehensive assessment at the next policy meeting.

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0.0 1.0 2.0 3.0 4.0 5.0 6.0

(Trillion yen)

(%)0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0 1.0 2.0 3.0 4.0 5.0 6.0

【Pre-QQE Expansion (Oct 2014)】(Trillion yen)

(%)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0 1.0 2.0 3.0 4.0 5.0 6.02 year bonds 5 year bonds 10 year bonds 20 year bonds 30 year bonds 40 year bonds

【Pre-NIRP (Jan 2016)】(Trillion yen)

(%)

【Pre-QQE (March 2013)】

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0 1.0 2.0 3.0 4.0 5.0 6.0

(Trillion yen)

(%)

【Present (Oct 2016)】

- 14 -



Fig. 2-4 Volatility of JGBs

Note: Daily data up to and including Nov 16, 2016. Source: Japan Exchange Group, JSDA, QUICK, Bloomberg

2-2. BOJ’s “Whale in the Pond” Issue 2: ETF Market

Not only the JGB market, but also the ETF market is now described as being

government-controlled. Fig. 2-5 shows the flow of trading by investment sector in the ETF market.

The BOJ started to buy ETFs in December 2010, but the bank accounts for the majority of buying

since 2011. At the Monetary Policy Meeting in July 2016, the BOJ increased the amount for ETF

purchases from 3.3 trillion yen to 6 trillion yen (from USD 300 billion to 545.5 billion). In September

2016, the Bank spent approximately 800 billion yen (USD 7.3 billion) on buying, exceeding the 2012

performance in a single month, providing plain evidence of a government-controlled market.

Fig. 2-5 Trading Value of ETFs by Investor Type (Flow)

Note: 1.Data excludes foreign ETFs.

2.We assume that the BOJ does not make direct ETF purchases through the stock exchanges, and that it does not sell any of the ETFs that it has purchased.

3. Data excludes ETFs that to support firms proactively investing in physical and human capita.

Source: Tokyo Stock Exchange, BOJ

1.0

2.0

3.0

4.0

5.0

6.0

15/01 15/06 15/12 16/06

【S&P/JPX JGB VIX】(Point)

-40-30-20-10

010203040

12:1 12:3 13:1 13:3 14:1 14:3 15:1 15:3

MediumLongSuper longTotal

【JGB Quarterly Transaction Volume】(YoY, %point)

(Quarterly)

16:3

16/11

0

50

100

150

200

250

300

15/01 15/07 16/01 16/07

【L-T JGB Futures Price Range to Transaction Volume Ratio】

16/11

(2012=100)

(Daily)

-0.6-0.4-0.20.00.20.40.60.81.01.2

-202468

10121416

15/01 15/07 16/01 16/07

Bid/Ask SpreadL-T Rate (RHS)

16/11

【L-T JGB Bid/Ask Spread】 (L-T Rate)(Bid-ask spread)

(Daily)(Daily)

Volatility Tightness

ResiliencyVolume

-1.0

0.0

1.0

2.0

3.0

4.0

2011 2012 2013 2014 2015Individuals Foreigners BOJ Financial and Securities Institutions Other Companies

(Trillion yen)

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

16/01 16/03 16/05 16/07 16/0916/09

(Trillion yen)

(Monthly)Selling

Buying

(CY)

- 15 -



The BOJ mainly buys ETFs linked to three indices (TOPIX, Nikkei 225, and JPX 400)2. Fig. 2-6

shows the fluctuations in the three indices. The market capitalization of the First Section of the Tokyo

Stock Exchange is extremely large at 516 trillion yen (USD 4.7 trillion) as of October 31, 2016, but

the influence of the BOJ buying is gradually increasing. At the Monetary Policy Meeting on October

31, 2014, the BOJ decided to increase the annual spending amount from one trillion yen to three

trillion yen (from USD 9.1 billion to 27.3 billion). There was a large increase in the stock indices

toward the end of 2014, which can be seen in Fig.2-6. In early 2016, the indices fell in apparent

support of lower prices due to cheap oil, turmoil in the foreign markets, and the appreciation of the

yen. There were claims that “BOJ buying boosted the Nikkei Average by 1,000~2,000 yen” (USD

9.1~18.2), and we can say that the BOJ increased its presence in the stock market as well as the JGB

market.

Fig. 2-6 Trend of Major Stock Indices

Note: Daily data up to and including Nov 16, 2016. Source: NEEDS-FinancialQUEST

The BOJ holdings of ETFs exceeded 10 trillion yen (USD 90.9 billion) at the end of October 2016.

The Bank, now the biggest player in ETF market, has been only buying and not selling ETFs.

However, if ETF prices should decline sharply, the BOJ would need to set aside adequate reserves to

cover for the losses, which would reduce the Bank’s profits.

Fig. 2-7 estimates the BOJ’s ETF holdings. The BOJ has bought ETFs linked to the three indices

in proportion to the total market capitalization of each issue, partially revised at the September 2016

monetary policy meeting. For this estimation, we used data for 20 issues as of the end of October 2016

handled by the Japan Exchange Group, and selected from the ETFs linked to the three indices. Since

the BOJ spending on ETFs has been constant during the month, the purchasing price is proportionally

distributed according to market capitalization per issue at the end of the month prior to the day of

purchase. In our estimation, the average acquisition price is currently lower than the current share

price, resulting in unrealized profits for the BOJ. ETF market capitalization totaled 15.8 trillion yen

2 The BOJ also purchases ETFs to support firms proactively investing in physical and human capital.

0

500

1,000

1,500

2,000

2,500

0

5,000

10,000

15,000

20,000

25,000

11/01 12/01 13/01 14/01 15/01 16/01

Nikkei225 JPX Nikkei400 TOPIX（RHS）

16/11

（Daily）

(Yen, Points) (Points)

- 16 -



(USD 143.6 billion) at the end of September 2016, with the BOJ accounting for 69% of the total

amount.

Fig. 2-7 BOJ’s ETF Holdings

Note: 1. We assume that the BOJ does not make direct ETF purchases through the stock exchanges, and that it does not sell

any of the ETFs that it has purchased. 2. Data does not take into account the difference between each ETF’s operational performance and stock index, dividends and various fees.


Although the BOJ buys large quantities of ETFs, share prices could potentially make a sharp fall.

Looking at annual fluctuation rates for the Nikkei Stock Average since FY2001, we find that it was

negative for seven years, the average magnitude of decrease being 19.0%, and the largest decrease

was 35.3% in FY2008, the year of the collapse of Lehman Brothers3. Fig. 2-8 summarizes the

valuation amounts and the valuation profit/loss if the stock price decreases by 19.0% or 35.3%. The

estimation for the end of FY2017 was prepared on the basis of the estimate at the end of September

2016, assuming that half of the annual purchases were bought at current share price levels.

If there is a drop of 19.0% at the end of 2017, the loss on valuation would be 1.7 trillion yen (USD

15.5 billion), and if there is a drop of 35.3%, the loss on valuation would be 3.9 trillion yen (USD 35.5

billion). Ordinary income at the BOJ for the fiscal year ending March 2016 was 800 billion yen (USD

7.3 billion), net assets 3.5 trillion yen (USD 31.8 billion), and net worth including account reserves 7.4

trillion yen (USD 67.3 billion). At present, there are no reserves for ETFs4, and even at around half of

the average drop in the past, there would be a deficit, causing great harm to finances. The BOJ has not

made clear what it intends to do with its ETF holdings upon its exit operations. The BOJ has started

selling equities bought in the past from April 2016, planning to offload 1.3 trillion yen-worth (USD

11.8 billion-worth) of equities in the next 10 years. By the end of FY2016, the BOJ’s ETF holdings is

expected to amount to 10 times that of equities; if it were to sell off its massive ETF holdings, the

process would be lengthy, and the BOJ would be prone to facing long-term risk exposures.

3 Estimated from the opening price of the first business day of April and the closing price of the last business day of March. 4 The BOJ has been accumulating reserves, and posted net transfers to provisions for unrealized losses on index-linked exchange-traded funds in the settlement of accounts for FY2010, but these were terminated in the FY2011 settlement of accounts.

（End of the Month）Nikkei

225TOPIX

JPX-Nikkei

400Total

Nikkei225

TOPIXJPX-

Nikkei400

TotalNikkei

225TOPIX

JPX-Nikkei

400March 2011 101 104 - 204 99 102 - 201 9,921 885 -March 2012 447 427 - 874 491 455 - 947 9,172 800 -March 2013 822 751 - 1,572 1,112 988 - 2,099 9,160 787 -March 2014 1,518 1,350 - 2,868 2,058 1,767 - 3,825 10,934 919 -March 2015 2,442 2,098 31 4,571 3,724 3,115 34 6,872 12,598 1,039 13,074March 2016 4,035 3,388 145 7,567 4,660 3,855 129 8,645 14,509 1,184 13,611Sept 2016 5,301 4,372 249 9,922 5,844 4,778 231 10,853 14,920 1,210 12,787

(Billion yen) (Yen, Points)Purchased Amount Valuation at Market Prices Average of Purchase Price

- 17 -



Fig. 2-8 Simulation Result in the Case of Market Prices Fall

Note: 1. Case1: Average of years the Nikkei 225 index YoY change turned negative from FY2001 onward (average

over 7years: -19%). 2. Case2: Largest % fall in the Nikkei 225 index YoY change (FY2008: -35%)


The monopoly on the ETF market and the risk of a decline in prices are not the only problems

involving BOJ purchases of ETFs. By buying ETFs, the BOJ becomes the largest shareholder in many

companies. Fig. 2-9 indicates the extent of the BOJ’s indirect holdings of shares in index component

issues through ETFs. For the estimation, we used the weights of individual issues in each index, the

indexed ETF holdings shown in Fig. 2-7, and the closing price on September 30, 2016. Moreover, we

judged whether the Bank is the largest shareholder based on the number of shares held by the leading

shareholders excluding trust accounts, and the number of actual BOJ share holdings. Results indicated

that the bank is already the largest shareholder of approximately a quarter of the companies on the

Nikkei 225. Furthermore, the Bank’s holding ratio of floating stocks now exceeds 10% in 35

companies, over 40% in some. The BOJ’s massive holdings leads a fall in floating stocks, which may

cause individual stock liquidity to deteriorate.

Fig. 2-9 BOJ’s Rise to Top Shareholder of Companies

Note: 1.Data excludes security investment trust account, 2. Family shareholders are not taken into consideration. Source: BOJ, NEEDS-FinancialQUEST

Since the BOJ holds shares indirectly through ETFs, the shareholder voting right is held by the

company operating the ETFs. It has been pointed out that “since ETF commissions are low, there is no

time for operating companies to spend on analysis or using a proxy to represent shareholders. The

Nikkei225

TOPIXJPX-

Nikkei400

Nikkei225

TOPIXJPX-

Nikkei400

TotalNikkei

225TOPIX

JPX-Nikkei

400Total

As of Sept 30, 2016 16,450 1,323 11,846 5,844 4,778 231 10,853 543 406 -18 931

Case 119% Fall in Market Prices

13,324 1,071 9,596 4,734 3,870 187 8,791 -567 -502 -62 -1,131


10,643 856 7,665 3,781 3,092 149 7,022 -1,520 -1,281 -100 -2,900

As of March 31, 2017 16,450 1,323 11,846 6,643 6,764 296 13,703 538 412 -18 931


13,324 1,071 9,596 5,381 5,479 240 11,099 -724 -873 -75 -1,672


10,643 856 7,665 4,298 4,376 192 8,866 -1,807 -1,976 -123 -3,906

(Yen, Points) (Billion yen)

Market Prices Valuation at Market Prices Valuation Gain or Loss

Number of Companiesof which the BOJ is

the Largest Shareholder

Number ofCompanies Surveyed

% of Total

Nikkei 225 54 225 24.0JPX-Nikkei 400 36 395 9.1TOPIX 55 1980 2.8

- 18 -



market oversight role is hollowed out by the use of proxies to represent shareholders”. In February

2014, the Financial Services Agency published the Japanese Version of the Stewardship Code, a

collection of rules for the “responsible institutional investor.” Although the Government Pension

Investment Fund (GPIF), which manages employee pensions and national pensions, entrusts the

management of shares to other institutions, it has announced a policy of meeting its stewardship

responsibilities by cooperating with the entrusted institutions. The BOJ is said to be the real

shareholder of long-term holdings, and if the BOJ continues to buy, its presence will only increase.

The BOJ may have to find some way of fulfilling its responsibilities as a major shareholder.

2-3. Limits to the BOJ’s JGB Purchases on the Horizon?

At the Monetary Policy Meeting at the end of September 2016, the BOJ revised its buying policy

for government bonds as of October 2016. The bank will reduce investment in bonds with remaining

term of less than one year, 5 to 10 years, and more than 10 years, and increase investment in bonds

with terms between 1 and 5 years. The bank is also adding the 1 to 3 year, and 3 to 5 year

classifications to the 1 to 5 year category, and the 10 to 25 years, and the 25 years or higher

classifications to the 10 years or higher category, further refining the categories of remaining terms for

intended purchases of government bonds. Overall, the lower limit for monthly purchases has been

reduced to 680 billion yen (USD 6.2 billion) and the upper limit has been reduced to 1.2 trillion yen

(USD 10.9 billion), but there is no change to the policy of spending 8 to 12 trillion yen (USD 72.8 to

109.1 billion). By introducing QQE with Negative Interest Rate and QQE with Yield Curve Control

policies, the BOJ appears to have shifted its attention to the policy rate, though the Bank has not yet

abandoned “quantity.”

According to the BOJ’s Flow of Funds Accounts, the balance of BOJ holdings in government

bonds and the Fiscal Investment and Loan Program (FILP) bonds was 344.2 trillion yen (USD 3.1

trillion) in June 2016 (Fig. 2-10). Looking at the balance of holdings by entity (Fig. 2-11), the BOJ

accounts for the highest ratio (35%), an increase from the same period in the previous year (30%).

- 19 -



Fig. 2-10 JGB Holdings by Entity

Note: 1. “Financial institutions for small businesses” includes the Japan Post Bank.

2. JGB includes FILP (fiscal investment and loan program) bonds and excludes Treasury discount bills. Source: Bank of Japan, Flow of Funds Account

Fig. 2-11 Ratio of JGB Holdings by Entity (End of June 2016)

Note: 1. “Financial institutions for small businesses” includes the Japan Post Bank.

2. JGB includes FILP (fiscal investment and loan program) bonds and excludes Treasury discount bills. Source: Bank of Japan, Flow of Funds Account

For how long can the “quantitative” part of QQE continue? In Fig. 2-12-1, we trace the flow of

long-term government bond transactions. We verified the limits for bond purchases based on data for

September 2015 in Kimotsuki, Samikawa, and Takahashi (2016) which pointed out the limits will be

reached in June 2017. For this report, we have updated the analysis using data available up to March

2016. Other than reducing the amount of Japan Post Bank’s disposable government bonds to 34.3

trillion yen (USD 311.8 billion), the prerequisites concerning the conditions for bond holding ratios

etc are the same as in Kimotsuki et al. (2016).

0

100

200

300

400

00:1 01:1 02:1 03:1 04:1 05:1 06:1 07:1 08:1 09:1 10:1 11:1 12:1 13:1 14:1 15:1 16:1

Central bank Domestic banksFinancial institutions for small businesses InsurancePension funds Overseas

(Trillion Yen)

(Quarterly)

16：2

Central bank35%

Insurance22%Financial institutions for

small businesses11%

Domestic banks 9%

Public pension 5%

Overseas 6%

Mutual aid insurance 4%

Pension funds 4%

Agriculture, Forestry and Fisheries financial

institutions 3%

Households1%

- 20 -



Fig. 2-12-1 Flow of Long-Term JGBs

Fig. 2-12-2 JGBs Available for Sale (Mar 2016)

BOJ’s annual purchases ×N years=Net annual long-term JGB issuance ×N years + Amount available for sale by the private sector

Source: Summary Reports released by banks and other financial institutions and their websites

We estimate that the amount of disposable long-term government debt held by private banks,

insurance companies, public pension funds, and other public financial institutions totals 114.1 trillion

yen (USD 1.0 trillion). In December 2015, the BOJ introduced supplementary measures that expanded

eligible collateral for its provision of credit, accepting foreign currency-denominated loans on deeds

and financial institutions' housing loans portfolio. The value of collateral is calculated by multiplying

the market value of the pledged asset or the outstanding principal amount by an assessment rate

(haircut rate) according to the remaining term or risk (Fig. 2-13). Taking the supplementary measures

into account, we calculate that the extra room for JGBs amounts to 11.7 trillion yen (USD 106.4

billion) as shown in Fig. 2-12-2.

①Totalassets

(Tril. yen)

②TotalJGB

holdings(Tril. yen)

②/①Ratio (%)

Shift in ratio（％）

③Total JGBholdings after

shift(Tril. yen)

④

Supplementarymeasures

②-③+④

JGBs availablefor sale

(Tril. yen)

Banks 1,043.4 95.7 9 5 52.2 11.7 55.2

Japan Post Bank 207.1 82.2 40 ― 47.9 0.0 34.3

Life insurance companies 285.6 102.7 36 36 102.7 0.0 0.0

Japan Post Insurance 81.5 44.2 54 34 27.7 0.0 16.5

Property insurance companies 30.9 5.9 19 18 5.6 0.0 0.3

Public pension funds 171.8 67.9 40 35 60.1 0.0 7.8

Total 1,820.3 398.6 22 Total 296.2 11.7 114.1

JGB holdings (End of Mar 2016) JCER Assumptions

- 21 -



Figure 2-13 BOJ Eligible Collateral and their Values (Haircut rate) as of September 2016

Source: Bank of Japan, Eligible Collateral

According to our latest estimation, the limits to the BOJ’s JGB purchases will be reached in

summer 2017. However, the amount of JGB purchases by the BOJ is based on their purchasing policy

as of September 2016. The BOJ’s JGB purchasing program was recently modified in October 2016,

resulting in a decline in JGB purchases that month. If JGBs are purchased at the same pace as in

October 2016, we find that the limit to BOJ’s purchases will be reached later, in fall 2017. On the

other hand, with the introduction of BOJ’s fixed-rate purchase operation of JGBs under QQE with

Yield Curve Control, the BOJ’s JGB purchases may expand, in which case, purchasing limits will be

reached earlier than estimated. In fact, on November 17, the Bank offered to buy unlimited amount of

JGBs with between one and five years left to maturity.

Will the BOJ continue to buy JGBs? Banks and the Japan Post Bank hold abundant disposable

government bonds, and if they disposed of all of them, they would have the cash equivalent at hand.

They are likely to keep deposits in Policy Rate Balance of the BOJ current accounts where negative

rate applies. This could badly effect on Japan’s financial system. There may be some investment

options, including regional revitalization funds, PFI projects, and overseas infrastructure funds.

However, their current scale seems insufficient for investing all the funds received from the sale of

JGBs. Thus, there is a risk of reluctance among private financial institutions and investors to sell their

JGBs to the BOJ, to avoid increasing the Policy Rate Balance, which may have an adverse impact on

their profits. The higher the prices of JGB purchases, the larger the loss incurred by the BOJ will

become.

JGBsForeign bonds

（converted to yen）Asset-backed bonds

Corporate deedloans

Government deedloans

Dollar-denominated

Loans on Deeds

Trust beneficiaryinterests of

housing loansUp to 1 year 99 87 97 96 97 881 - 3 years 99 87 97 91 95 803 - 5 years 99 87 97 85 90 705 - 7 years 98 87 96 75 85 657 - 10 years 98 87 96 70 80 5510 - 20 years 97 87 95 ― ― ―20 - 30 years 96 87 94 ― ― ―Over 30 years 94 87 92 ― ― ―

RemainingMaturity

Applicable Rate of Collateral to Market Price (%) Applicable Rate of Collateral to Outstanding Principal Balance (%)

60

- 22 -



BOJ’s Foreign-Bond Purchases

At present, the BOJ is buying long-term government debt, ETFs, J-REIT, corporate bonds, and

commercial paper (CP). Even as the BOJ continues to buy large quantities of these securities, a debate has

surfaced about whether foreign government bonds should be included among the buying options.

According to Koichi Hamada, Special Advisor to the Cabinet, “buying foreign government bonds is an

option for the BOJ if it is difficult for the government to intervene in the market amid the ongoing pressure

of the high yen on the currency markets”. Kazumasa Iwata, President of JCER, has also been proposing the

creation of a 50 trillion yen (USD 454.5 billion) fund to buy foreign bonds, in the wake of a financial crisis.

The purchase of foreign government bonds has also been discussed at past Monetary Policy Meetings. It

started at the Monetary Policy Meeting on October 11 and 12 in 2001 when Nobuyuki Nakahara, then a

policy board member, observed that the Bank should consider buying foreign government bonds as a

backup for buying JGBs. At the Monetary Policy Meeting on November 15 and 16, 2001, there was a

formal proposal to “start to buy foreign government bonds as soon as the preparations for the practical

systems are in place in case it is judged necessary to ensure smooth operations”. At the time, a prolonged

deflation was expected, and since it was highly likely that further monetary easing would take place in the

future, the proposal was based on awareness of the need to increase the means of supplying funds. The

objectives of buying foreign government bonds are (1) to increase the capacity for supplying funds

(monetary base), and (2) to diversify the means of supplying funds at the BOJ. A method of making

constant purchases of foreign government bonds for a fixed sum every month was proposed to make it

clear that the purpose was not the foreign exchange intervention.

The Bank of Japan Act poses problems when buying foreign government bonds. The following are two

excerpts from the Bank of Japan Act on the purchase of foreign government bonds and partial statements

by board members at the time.

Policy board member Miyako Suda insisted that “the purpose of monetary policy is not to stabilize the

currency value, including the exchange rate, but to stabilize prices which are the internal value of the

currency. If the BOJ buys foreign currency and foreign debt as part of monetary adjustment, an essential

condition is that there is no impact on the exchange rate, or at least no intention. Even if the exchange rate

moves toward yen depreciation more than expected, we need to have the resolve to continue buying foreign

debt”.

Article 33 of the Bank of Japan Act: In order to achieve the purpose prescribed in Article 1, the Bank of

Japan may conduct the following business: [….] (iii) Buying and selling of commercial bills and other

negotiable instruments (including those drawn by the Bank of Japan in this item), national government

securities and other bonds, or electronically recorded claims;

Board member Nobuyuki Nakahara: Article 33 includes “national government securities and other

bonds” in day-to-day business. Of course, this includes foreign government bonds, so if there is a need to

buy and sell foreign debt in order to supply yen as part of normal business, this is clearly possible.

At the Monetary Policy Meeting at the time, the following points were cited as the advantages of

buying foreign debt: (1) Ease of providing current deposits since there is low substitution with other base

money than government bonds; (2) Unlike increasing operational funds to buy long-term government

bonds, there is no risk of exciting fears around fiscal discipline among market participants; (3) It is easier

to secure neutrality compared to purchases of shares and corporate bonds. On the other hand, there were

also concerns about the need to buy foreign debt, and whether the currency authorities in the United States

- 23 -



and neighboring countries would fully understand the situation.

Article40 (1) of the Bank of Japan Act states;

“The Bank of Japan may, when necessary, buy and sell foreign exchange on its own account or as an agent

handling national government affairs pursuant to Article 36, paragraph 1, and it may also buy and sell

foreign exchange on behalf of foreign central banks, etc. (foreign central banks and those equivalent

thereto; the same shall apply hereinafter) or international institutions (international institutions of which

Japan has a membership, including the Bank for International Settlements; the same shall apply

hereinafter) as their agent in order to cooperate with them as the central bank of Japan.”

The argument arose to whether the BOJ purchase should invade Article40 (2) of the Act which states as

follows;

“The Bank of Japan shall buy and sell foreign exchange as an agent handling national government affairs

pursuant to Article 36, paragraph 1, when the purpose of the buying and selling is to stabilize the exchange

rate of Japanese currency.”

Nakahara insisted that even if the BOJ bought foreign government bonds as part of monetary

adjustment, there would have been no impact on the exchange rate, so long as it was not intended as

foreign exchange intervention. The proposal to buy foreign government bonds continued until March 2002,

and since then there have been no discussions of buying foreign debt for a long time.

Currently, with the approaching limits on BOJ purchases of JGBs, there is once again some leeway to

discuss the purchase of foreign government bonds.

- 24 -



3. How will BOJ bear Potential Losses?

3-1. Under what Circumstances will BOJ fall into the red?

BOJ prepares for Loss incurred in Exit Phase

According to the BOJ income statement and operating report for FY2015, the interest from

long-term government bonds was 1.3 trillion yen (USD 11.8 billion), accounting for approximately

82% of ordinary revenue at the BOJ. This tells us that the BOJ earns most of its profit from the

interest from long-term government bonds. On the other hand, of the operating expenses amounting to

834.5 billion yen (USD 7.6 billion), approximately 49% was foreign exchange losses (408.3 billion

yen; USD 3.7 billion), and approximately 27% net interest payments on excess reserves (221.6 billion

yen; UDS 2.0 billion). Fig. 3-1 presents fluctuations in operating profits and legal reserves at the BOJ.

In FY2015, operating profits at the BOJ declined by as much as 55% YoY. The main reason was that

foreign exchange related profit/loss was converted to losses due to the appreciation of the yen.

Consequently, if the yen appreciates further, or the ETF market shrinks, there is potential for operating

profit at the BOJ to fall.

Fig. 3-1 Legal reserves of BOJ

Note: Net income = Operating profits - (Special losses - Taxes (Provision for corporate income tax, inhabitants taxes, and

enterprise taxes)) Source; BOJ, Financial Statements

As argued in Part 2 of this report, the BOJ is now criticized as being another “whale in the pond” in

the ETF market. ETFs have risk for a loss of principal, which might damage the soundness of the BOJ’s

balance sheet. The fluctuations of stock prices as well as foreign exchange rate of the yen might have

larger effect on the profits and losses of the Bank. It will also be difficult for the central bank to shrink

its balance sheet in its “exit” phase, without exerting a negative impact on the market and incurring

heavy losses that lead to national burden. Coordination between the government’s debt management

policy and the Bank’s monetary policy needs to be taken into account.

- 25 -



The BOJ sets aside as legal reserve funds a sizeable 5% of the current term surplus based on final

profits. Looking at the fluctuations in the legal reserve funds presented in Fig. 3-1, 20% of the surplus

in FY2013 when QQE was introduced, and 25% in the following fiscal year, were set aside as legal

reserve funds. In FY2015, only 5% of the current surplus was recorded as legal reserve fund.

As of the FY2015 settlement of accounts, the BOJ revised the provisions system to facilitate the

transfer of approximately 50% of the difference between the interest rate paid on excess reserve

balances and the interest income from the government bond holdings to the transfer, providing for

possible losses on bond transactions. In FY2015, the BOJ set aside 450.1 billion yen (USD 2.0 billion)

as transfer to provision for possible losses on bonds transactions. As long as the BOJ operates in such

a way that the equity ratio does not fall below 8%, the bank can freely break into the provisions for

losses on bond transactions (BOJ Accounting Rules Article 18-1). This allows for a high degree of

freedom compared to the legal reserve funds, which cannot be withdrawn unless a loss (deficit) arises,

and for the BOJ it is a useful way of maintaining fiscal soundness. However, since the BOJ equity

ratio was 8.05% at the end of FY2015, it must be noted that the actual degree of freedom under the

current circumstances is low.

Interest paid on Excess Reserve becomes Heavy Burden

In FY2015, BOJ net assets including legal reserve funds and provisions for loss on bond

transaction was 7.4 trillion yen (USD 67.3 billion). Has the BOJ accumulated sufficient funds relative

to the losses that would occur at the time of a future exit?

The bank offers 0.1% interest on reserves exceeding the legally mandated reserves held in BOJ

current accounts. Since the introduction of NIRP, the BOJ has divided its current accounts into three

tiers with an interest rate of 0.1% applicable to the balance at the first tier, the basic balance, which

has been unchanged at approximately 210 trillion yen (USD 1.9 trillion). In FY2015, the amount of

interest that the BOJ paid to financial institutions totaled 221.6 billion yen (USD 2.0 trillion),

increasing by approximately five times compared to FY2012, the year before the introduction of QQE.

Fig. 3-2 presents the fluctuations in BOJ’s monetary base. Since the introduction of QQE in April

2013, the monetary base has expanded with a focus on BOJ current accounts. In FY2013 ending

March 2014, the BOJ current account balance increased by 59.8 trillion yen (USD 0.5 trillion) over

the previous year; in FY2014 it was up by 71.6 trillion yen (USD 0.7 trillion), and in FY2015 by 74.9

trillion yen (USD 0.7 trillion).

- 26 -



Fig. 3-2 BOJ’s Monetary Base

Note: Monetary base = Banknotes in Circulation + Coins in Circulation + Current Account Balances (Current Account

Deposits in the BOJ). Source: BOJ, Monetary Base and the BOJ’s Transactions

The Bank can enjoy the benefits of receiving interest from its JGB holdings while keeping interest

payments on the Basic Balance of current account constant. On the other hand, when inflation rate

exceeds the 2% target and monetary policy enters the “exit” phase, it is conceivable that the BOJ will

hike the policy rate. The interest rates on JGBs which the Bank hold are fixed and will remain as low

as they were during the period of low interest even if they have to raise the policy rate. As of the end

of FY2015, excess reserves are approximately 230 trillion yen. If interest were raised to 2% due to

prices reaching the 2% target, the BOJ would pay 4,600 billion yen (USD 41.9 billion) in interest to

financial institutions relative to the excess reserves at the end of FY2015.

If we assume that an annual pace of increase of excess reserve in the current account balance at the

BOJ is 70 trillion yen (USD 0.6 trillion) and the interest on excess reserves is raised to 2% as the exit

phase nears during FY2018, the BOJ will be saddled with an additional 8.8 trillion yen (USD 0.1

trillion). In FY2015, operating profits at the BOJ was 762.6 billion yen (USD 6.9 billion); even in

FY2014, a robust year, operating profits was 1.7 trillion yen (USD 15.5 billion). Consequently, the

BOJ would post a loss of approximately 7.1 trillion yen (USD 64.5 billion) at the end of FY2018 even

if the interest were subtracted from ordinary income for FY2014, a robust year. Such loss is close to

the BOJ net assets of 7.4 trillion yen (USD 67.3 billion), which includes legally mandated reserves,

transfer to provision for possible losses on bond transactions, and other account reserves. Therefore, it

cannot be said that the BOJ is adequately prepared for losses occurring in the exit phase, and it is a

matter of urgency that the BOJ undertakes further preparation for its exit strategy.

3-2. Fiscal Dominance and Monetary Dominance

Japan’s Monetary Policy: Fiscal or Monetary Dominance?

Japan’s outstanding debt as a percentage of GDP is forecast to be 233.1% in CY2016. This is an

extremely large proportion even when compared to major countries (Fig. 3-3). A low interest rate

050

100150200250300350400450

07/01 08/01 09/01 10/01 11/01 12/01 13/01 14/01 15/01 16/01

Current Account BalancesCoins in CirculationBanknotes in Circulation

QQE

（Trillion yen）

16/10

Expansion of QQE

NIRP

（Monthly）

- 27 -



environment will incentivize the government to issue long-term government bonds. Is the reason for

easing the monetary policy to stabilize prices or to control the cost of interest payments incurred by

government? Since easing monetary policy will have an effect on both points (an unintentional effect

on the latter), it is difficult to draw clear lines.

Fig. 3-3 General Government Gross Financial Liabilities

Source: OECD, Economic Outlook No.99 (June 2016）

The BOJ is lowering interest rates to achieve the 2% price target. On the other hand, it is possible

to control the cost of interest payments if debt is issued in a low interest environment. Fiscal

dominance is a situation where the independence of the central bank fades and the fiscal conduct of

the government influences monetary policy, having an impact on prices. As a result of analyzing

government debt in twenty advanced economies, Greenlaw, Hamilton, Hooper and Mishkin (2013)

found that monetary easing is a contributing factor when the government and parliament are acting

appropriately toward sound public finances. However, in the reverse case, monetary policy is

dominated by fiscal policy (fiscal dominance). In other words, whether or not the government takes

appropriate measures toward sound public finances is the watershed between fiscal dominance and

monetary dominance.

Fig. 3-4 shows the fluctuations in Japan’s primary balance. The primary balance in Japan has been

improving since the collapse of Lehman Brothers, and has continued to improve since 2013 when the

BOJ introduced QQE. Consequently, we can say that there is no fiscal dominance over monetary

policy.

0

50

100

150

200

250

2001 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Japan United States United KingdomGermany France ItalyCanada Greece

（% of Nominal GDP）

（CY）

- 28 -



Fig. 3-4 Transition of General Government Primary Net Lending/Borrowing in Japan

Source: IMF, World Economic Outlook Database (October 2016)

Greenlaw et al. (2013) also indicate that countries with government debt ratio exceeding 80%

recording a current account balance deficit, run a high risk of falling into fiscal dominance. Although

Japan’s government debt ratio is far in excess of 80%, Japan runs a current account surplus, so the

indication does not apply in this case. However, if fiscal dominance arises, it is conceivable that

confidence in the currency will disappear and hyper-inflation might develop. In order for Japan to

avoid such a situation, the government must make every effort to improve the primary balance, and to

achieve a primary balance surplus.

Canada’s Case of Monetary Financing – Was it a success?

Although fiscal dominance is regarded as being likely cause hyper-inflation, there is a case in

Canada where fiscal dominance based on clear rule had contributed to getting over from deflation.

Between 1935 and 1975, the Bank of Canada implemented monetary finance by directly purchasing

government bonds from the Canadian Government. The context was the government’s goal of

securing funding for the Second World War and the postwar recovery. Fig. 3-5 presents the

relationship between the consumer price index and the monetary financing ratio (MFR), i.e. the

proportion of total public debt held by the Bank of Canada. As a result of monetary financing, the

consumer price index, which had been close to 0% in the early 1950s, recovered to close to 5% in the

late 1960s. Since the introduction of inflation targeting in 1991, fluctuations in the consumer price

index have been relatively small.

-50-45-40-35-30-25-20-15-10-50

2001 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

General government primary netlending/borrowing

(Trillion yen)

(CY)

IMF Forecast

- 29 -



Fig. 3-5 Monetary financing and inflation in Canada

Note: 1. Monetary financing ratio is the proportion of total public debt held by the Bank of Canada or government.

2. The shadowed area indicates the period of monetary financing in Canada (1935-75). Source: CANSIM, OECD, Ryan-Collins (2015)

Ryan-Collins (2015) indicates that the example of Canada is not one of inducing hyperinflation;

rather it has had a positive influence on early withdrawal from deflation. However, Canada suffered

from high inflation as of the mid-1970s. As a result, Canada adopted monetary targeting, which

reduced MFR from approximately 20% in 1980 to approximately 9% in 1985, and as a result the

consumer price index also declined. In 1991, inflation targeting was introduced. As a factor leading to

the introduction of inflation targeting in Canada, Ito and Hayashi (2006) cite a rapid increase in

outstanding government debt as of the 1980s (Fig. 3-6), and a loss of confidence in the ability of the

government and the central bank to manage macroeconomic policy due to the relatively high inflation

that continued for a long time. Since introducing inflation targeting, Canada has kept the rate of

inflation within a range of approximately 1-3%.

Fig. 3-6 General Government Gross Financial Liabilities in Canada

Source: OECD, Economic Outlook No.99 （June 2016）

-5

0

5

10

15

20

25

30

46:1 50:1 54:1 58:1 62:1 66:1 70:1 74:1 78:1 82:1 86:1 90:1 94:1 98:1 02:1 06:1 10:1 14:1

Monetary Financing Ratio

Consumer Prices (2010 base, YoY)

（%）

16:3

（Quarterly）

Inflation Targeting

40

50

60

70

80

90

100

110

120

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

（% of Nominal GDP）

（CY）

- 30 -



Should Japan, a country suffering from long-term deflation, do what Canada has done and consider

monetary finance? In Japan, direct placement of government bonds by the BOJ is, in principle,

prohibited under Article 5 of the Public Finance Act5. The reason is that once the central bank starts to

finance the government by underwriting government bonds, the government loses fiscal discipline,

eventually running the risk of causing virulent inflation because the government is unable to apply the

brakes to increases in the money supply at the central bank.

Fig. 3-7 presents the relationship between the consumer price index and the ratio of JGBs held by

the BOJ among total outstanding JGBs. Since the introduction of QQE in 2013, the ratio of

government bonds held by the BOJ has risen. On the other hand, growth in the consumer price index

has not only slowed, but also even been in periods of decline. This indicates that there is no

correlation between trends in the consumer price index and the ratio of government bond holdings at

the BOJ during the entire period.

Fig. 3-7 JGB holdings rate and Consumer Price Index in Japan

Note: Core Core CPI = All items less food (less alcoholic beverages) and energy. Data excludes effects of the consumption

tax hike. Source: BOJ, Japan’s Flow of Funds Accounts; MIAC, Consumer Price Index

At present, the BOJ is buying JGBs issued on the market at a higher price than the original issuance

price. This increases the BOJ amortization burden and reduces the net interest receipt from JGBs. The

BOJ losses reduce the government revenue in the shape of a decrease in the BOJ’s remittance to the

national treasury.

In Canada, direct underwriting by the central bank is recognized in two adjacent provisions in the

Bank of Canada Act. One provision recognizes direct underwriting of government bonds by the

central bank, and the other stating that in case direct underwriting of government bonds exceeds one

third of the estimated government revenue, such loans shall be repaid before the end of the first

5 However, where the BOJ holds government bonds as a result of monetary control, the bonds that are nearing redemption can be refinanced by the state, but only within the amount approved by Diet resolution based on the proviso to Article 5 of the Public Finance Act.

-4

-3

-2

-1

0

1

2

3

4

0

5

10

15

20

25

30

35

40

98:1 99:1 00:1 01:1 02:1 03:1 04:1 05:1 06:1 07:1 08:1 09:1 10:1 11:1 12:1 13:1 14:1 15:1 16:1

JGB Holdings Rate

Core Core CPI (RHS)

(%)

(Quarterly)

16：3

(YoY, %)Inflation Targeting

- 31 -



quarter of the following fiscal year6. Is moderate monetary financing an option in Japan?

3-3. Government Bond Management Policy and Monetary Policy

Some argue that price fluctuations occur as a result of fiscal policy, specifically the quantity of

outstanding government bonds, and that the money supply has less impact.

The amount of outstanding public debt has continued to increase (Fig.3-8). Social welfare costs,

which account for a third of annual supply expenditures, have risen each year, and estimated to exceed

20 trillion yen (USD 0.2 trillion) for the first time in FY2016. Furthermore, according to MOF

estimates, the amount of outstanding public debt will reach to 1,030 trillion yen (USD 9.4 trillion) at

the end of FY2025.

Fig. 3-8 Outstanding Public Debt and Interest Paid

Note: 1. Amount of outstanding bonds = FY15: Estimates, FY16: Budget.

2. Interest paid = FY15: Revised budget, FY16: Budget. 3. The Ministry of Finance provisionally calculates the 10-year government bond yield for FY2016 at 1.6%. This is because that MOF estimated the rate higher to think the case the rate rise up rapidly.

Source: MOF, Documents regarding the Tax system and Finance in Japan

MOF preliminary calculations show that the cost of interest payments on government bonds is

estimated to be 21.9 trillion yen (USD 0.2 trillion) in FY2025, or 2 times the figure for FY2016. The

cost of interest rate payments will increase substantially when interest rates rise in the future.

According to the “Preliminary Calculations on the Impact of the FY2016 Budget on Annual

Expenditure and Revenue in the Future” announced by the MOF in February 2016, a fluctuation of

1% in the interest on 10-year bonds would cause debt-servicing costs to increase or decrease by 6

trillion yen (USD 54.5 billion) in FY2021. The average interest rate on the outstanding JGBs is

6 Bank of Canada Act

18 The Bank may… (i) make loans or advances for periods not exceeding six months to the Government of Canada or the government of a province on taking security in readily marketable securities issued or guaranteed by Canada or any province; (j) make loans to the Government of Canada or the government of any province, but such loans outstanding at any one time shall not, in the case of the Government of Canada, exceed one-third of the estimated revenue of the Government of Canada for its fiscal year…and such loans shall be repaid before the end of the first quarter after the end of the fiscal year of the government that has contracted the loan;

0

2

4

6

8

10

12

0

150

300

450

600

750

900

1975 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

（Trillion yen）

Outstanding Public Debt

Interest Paid (RHS)

16（FY）

838

9.9

（Trillion yen）

- 32 -



currently 1.1% (Fig.3-9). In case of a future rise in the interest rates for government bonds due to

some shock, such as a downgrading of the Japanese government bonds, or a move towards an exit

policy by BOJ, the cost of servicing the debt will greatly increase, leading to an increase in annual

expenditure.

Fig. 3-9 Interest on the Amount of Outstanding Bonds

Source: MOF, Documents regarding the Tax system and Finance in Japan

Fig. 3-10 shows that an increase in outstanding public debt is always a factor that pushes up the

cost of interest payments. There is high possibility that outstanding public debt will rise up, and

interest rates may also rise over time. Therefore, it is necessary to consider how to manage fiscal

administration, including management policies for government bonds, in order to enhance fiscal

sustainability.

Fig. 3-10 Decomposition Analysis of Interest Paid

Note: 1. Amount of outstanding bonds = FY15: Estimates, FY16: Budget.

2. Interest paid = FY15: Revised budget, FY16: Budget. Source: MOF, Documents regarding the Tax system and Finance in Japan

In Japan, a pattern of large government bond holdings continues with outstanding government

bonds, including fiscal investment and loan bonds, reaching 901.5 trillion yen (USD 8.2 trillion) at the

end of FY2015. In order to convert outstanding government bonds in a stable manner, government

bond management policies have been implemented to reduce the issuance of refunding bonds by

1.1

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

1975 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13

（FY）

（％）

14

-20-10

010203040506070

1976 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

Interest rateAmount of outstanding BondsInterest Paid

(%)

(FY)

- 33 -



extending the average redemption term for new bond issuance. As a result, the average redemption

term for government bonds has been increasing since FY1999, to reach nine years and two months by

FY2016 as shown in Fig. 3-11.

Fig. 3-11 Average Redemption Periods of JGBs issued each Year (based on Annual JGB Issuance)

Source: MOF, Debt Management Report

In addition, the scheduled amount of JGB issuance for FY2016 decreased by 5,200 billion yen

(USD 47.3 billion) to 147 trillion yen (USD 1.3 trillion) compared to early FY2015 (Fig. 3-12). The

government bond issuance plan for FY2016 includes initiatives aimed at securing liquidity in the

government bond market, and reducing government bond procurement costs. Looking at the

breakdown of government bond issuance in FY2016, the decrease in short and medium term bonds (5,

2, and 1 year bonds) was reduced while super-long bonds (40, 30, and 20 year bonds) saw an increase

in 40 year bonds and a reduction in 20-year bonds, bearing in mind market needs. There is also the

impact of low interest rates, but the overall picture is of an increase in issuing government bonds with

longer terms including super-long bonds issued on an annual basis of 20 trillion yen (USD 0.2

trillion).

Fig. 3-12 JGB Market Issuance

Source: MOF, Material for Advisory Councils on Government Debt Management

The average redemption period for government bonds have become longer in other major

4

5

6

7

8

9

10

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

（Years）

（FY）

9years 2months

4years10months

020406080

100120140160180

2008 09 10 11 12 13 14 15(Revised)

16(Revised)

Liquidity supply bids CMT, JGBi 11 years~ 10 years 2 to 3 years ~1year（Trillion yen）

（FY）

- 34 -



countries too (Fig. 3-13). The basic objectives of government bond management policy in these

countries are also similar to Japan: suppress procurement costs in the medium to long term while

considering risk. In recent years, in particular, measures have been taken to increase liquidity in the

government bond market and to apply strengthen financial regulation with the UK increasing the

frequency of auctions and reducing the issuance per auction.

Fig. 3-13 International Comparison of the Average Redemption Periods of Government Bonds

Source: MOF, Material for Advisory Councils on Government Debt Management

4

6

8

10

12

14

16

18

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Japan USA

Germany France

UK

（Years）

（FY）

- 35 -



Conclusion

The government needs to manage its financing without low interest rate by NIRP. Moreover, as

analyzed in Iwata et al. (2014), if the government issue longer maturity of JGBs the effect of monetary

policy may be vanished. Thus, to revitalize Japan’s economy, fiscal policy needs to cooperate with

monetary policy although it is also important to keep their dependence.

In this report, we have outlined the series of unconventional monetary policies that the BOJ has

introduced since the late 1990s. The BOJ has long been struggling to get out of deflation; however,

CPI data shows that it will require substantial time for the Bank to attain its 2% inflation target. The

BOJ will therefore be forced to continue buying large-scale JGBs and other assets, even though it

shifted its numerical target from the amount of supply of monetary base to the policy rate. It is now

criticized as being the “whale in the pond” in the ETF market, not to mention JGB market. ETFs have

the risk for a loss of principal, which might damage the soundness of the BOJ’s balance sheet. The

fluctuations of Japan’s stock prices, as well as the yen exchange rate can have larger effect on profits

and losses of the Bank. In addition, it will be difficult for the central bank to shrink its balance sheet in

the “exit” phase, without exerting a negative impact on the market and incurring heavy losses that lead

to national burden. It may thus be the time to consider the cooperation between the government and

the BOJ.

Copyright © 2016 JCER ______________________________________________________________________________________

Japan Center for Economic Research (JCER)

Nikkei Inc. Bldg. 11F 1-3-7 Otemachi, Chiyoda-ku, Tokyo 100-8066, Japan

Phone: +81-3-6256-7710 / FAX: +81-3-6256-7924

- 36 -



<Reference>

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Associated Risks. Japan Financial Report No.25, JCER.

http://www.jcer.or.jp/eng/pdf/kinyu20131213.pdf

Iwata, K., Fueda-Samikawa, I., Takahashi, E. (2016). “Risks and Challenges for BOJ after breaking

through ZLB - Accelerate move toward establishing a "Cashless Society"” QQE with a

Negative Interest Rate: Follow-up Report. Japan Financial Report No.30, JCER.

https://www.jcer.or.jp/eng/pdf/160413_report.pdf

Iwata, K., Fueda-Samikawa, I., Takahashi, E., & Kimotsuki, T. (2016). “Risks from Extending the

QQE Policy—Bank of Japan’s JGB Purchases to reach Limits in June 2017” QQE

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https://www.jcer.or.jp/eng/pdf/160127_fin_report2.pdf

Ryan-Collins, J. (2015). “Is Monetary Financing Inflationary? A Case Study of the Canadian Economy,

1935–75” Working Paper No. 848 Levy Economics Institute.

http://www.levyinstitute.org/pubs/wp_848.pdf

Originally in Japanese

Iwata, K., Fueda-Samikawa, I., Kikuchi, K., & Hariu, N. (2015). Was Monetary Policy affective under

the ZLB? Possibility that Decline in Natural Rate of Interest caused Prolonged Tightening.

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