Market Insight May 29, 2017

Japanese version of the OK rule and the cost benefits

of the exit strategy
Hajime Takata, Chief Economist

Interest in the BOJs exit strategy is growing now that the US has entered an interest rate hike cycle and with
the prospect of interest rate hikes by the ECB. However, there are three inconvenient truths that make the exit
difficult for the BOJ. There have been concerns that ongoing requirement for an excessively high price goal would
have the risk of a permanent zero. We have inserted a Japanese version of the OK rule into the mix with the 3
recommendations for the exit. Using a golf analogy, when there is close to being a goal curve, the play is taken to
be a curve in if those players nearby say it is OK even if the play is not strictly a curve in. So, in relation to the
BOJs price stability target of 2%, even if the 2% is not strictly achieved yet it is evident that this is the long-term
direction, a solution can be found if nearby persons say it is OK. Even in golf, the player him or herself is unable
to say OK, so there will need to be a sense that market players and the government are willing to say OK.
First and foremost, rushing the exit should not be the objective. However, the cost of maintaining very low
negative interest rates needs to be calculated. Here, we take the cost to be (1) the risk of damage to the financial
system when financial institutions are forced to live underwater due to negative interest rates, and (2) the risk of
the BOJs balance sheet. The following chart illustrates the cost to the BOJs balance sheet. Here, we consider the
impact on the market value of assets held on the BOJs balance sheet and the BOJ flows (income and expenditure)
if interest rates rise 1% in 2020. Were interest rates to rise by 1% four years from now, at the end of 2020, rather
than now, the cost would increase by (1) 1.1 trillion in income and expenditure, and (2) 5.3 trillion in market value

[ Chart 1: Increase in BOJ cost by delaying the exit ]

Cost of exit Increased cost of ongoing easing

(Units: trillion yen)
Delayed cost
End of FY2016 (1) End of FY2020 (2)
((2) (1))
Deterioration in income and expenditure from
a 1% hike in the interest rate paid on current 3.1 4.2 1.1
account deposits
Decline in market value for assets held by the
bank from a 1% hike in the interest rate paid 23.5 28.8 5.3
on current account deposits
(of which, bonds) (27.1) (39.1) (+12.0)
(of which, equities) (-3.6) (-10.3) (-6.7)
Note: - indicates an increase in market value
Source: Made by Mizuho Research Institute Ltd. (MHRI) based upon the Bank of Japan

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Market Insight May 29, 2017

of assets. Therefore, both alternatives will need to be debated when determining the future exit, given the cost of
bringing forward the exit and the continually growing cost accrued by delaying the exit.
Therefore, while it is very hard to predict the exit given the assumption of the three inconvenient truths, we
provide the following three proposals.

[ Chart 2: Three pillars for the exit strategy and cost benefit of monetary easing ]

2% price stability Excessively high hurdle

target

Lower target due to lower global inflation

OK Rule

Additional cost due to protracted easing

Reduce hurdle for exit
to achievable level
Completion
Roadmap of
Costs of monetary easing Abenomics
Prepare for increased
costs caused by Action towards the exit
higher interest rates

Commitment from the government for joint action on

restorative measures
Accord strategy
Cost of the exit shared by the government, the BOJ,
Benefits of monetary easing and financial institutions

Certain sustainable
Boost economic resilience together
economic growth

Bold monetary
easing Lower growth ceiling

Source: Made by MHRI

This chart indicates a roadmap towards the exit taking account of the costs and benefits of monetary easing.
An underlying concern is the absence of a rise in the necessary economic levels to reach the exit, given the
continuation of the excessively high price stability target. The OK rule referred to above is a practical approach
to realizing the excessively high price target. At the same time, it is hard to lift the actual economy itself through
monetary policy alone, and it will be vital for the government and the BOJ to take unified measures in a Japanese
style accord.
Another point highlighted by the inconvenient truths is the 5 jinxes. In past interest rate hike cycles of
Japan, the US, and Europe, the BOJ has always been the last to hike rates. So, an interest rate hike by the BOJ
assumes continuation of US rate hikes. Once the US cuts rates the grace period for Japan to hike rates will be
over. When Japan hiked interest rates and headed for the exit in the 4th cycle (the 2000 dot.com boom) and the
5th cycle (the 2006 subprime boom), it was pulled along by the global economic boom. This time, the 6th cycle
has begun with interest rate hikes in the US, but there are no signs of global economic momentum as there was
during the 4th cycle (2000) and 5th cycle (2006). The BOJ has set an excessively high price stability target, and
there is an absence of economic momentum, so there are concerns that the BOJ will be unable to move towards
the exit during this 6th grace period. There are also concerns of there being a permanent zero given the inability
to predict if the BOJ would be able to reach the exit even if there were a 7th cycle when the US once again starts

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Market Insight May 29, 2017

to hike interest rates. However, recognizing that there is a certain cost from ongoing super low interest rates, we
believe it is time to create a menu of realistic policy options. There are a number of versions for the calculations
provided on the first page, and we believe it is important to lift the taboo on having wide ranging debate on
issues including such menu.

This publication is compiled solely for the purpose of providing readers with information and is in no way

meant to encourage readers to buy or sell financial instruments. Although this publication is compiled on

the basis of sources which we believe to be reliable and correct, the Mizuho Research Institute does not

warrant its accuracy and certainty. Readers are requested to exercise their own judgment in the use of

this publication. Please also note that the contents of this publication may be subject to change without

prior notice.