Noah Smith and David Andolfatto think that Abenomics conclusively proves that quantitative easing boosts inflation. But Abenomics has nothing to do with quantitative easing and everything to do with qualitative easing. Every week, the Bank of Japan (BoJ) purchases Topix and Nikkei 225 ETFs till it hits an annual limit of around 1 trillion yen (see table below for last month’s purchases). It also purchases a much smaller amount of real estate investment trusts (REITs). Abenomics has nothing to do with increasing the “money supply” and everything to do with propping up asset prices.
How does the BoJ decide when to buy ETFs? It is widely believed that they follow the ‘1% rule’ i.e. “it would buy ETFs when the Topix index of all issues on the first section of the Tokyo Stock Exchange fell more than 1% in the morning session”. Abenomics takes the Greenspan/Bernanke put to its logical conclusion – why restrict monetary policy to implicit protection of asset prices when it can serve as an explicit backstop to the stock market?
What is the end-game of Abenomics? Obviously buying ETFs and REITs will increase inflation. But advocates of qualitative easing argue that such purchases will be a temporary policy that will be unwound when the economy achieves ‘lift-off’. This is pure fantasy. The BoJ will have to keep upping the ante to maintain even a small positive rate of inflation in a demographically challenged economy such as Japan. Already the ‘1% rule’ is no longer sufficient: “In the latter half of 2013, the bank apparently relaxed that rule, sometimes buying even when the decline was less than 0.5%”. In the long run the BoJ will end up owning an ever-increasing proportion of the private sector financial assets in the Japanese economy.