What Do You Get for the Central Bank That Already Bought Everything?

Economic growth and inflation expectations look shaky. What’s a central banker to do after exhausting every policy in the textbook?

The Federal Reserve and European Central Bank look likely to cut interest rates in the coming months, leaving the

Bank of Japan

8301 1.93%

in a quandary: It has gone practically as far as it can in cutting interest rates and purchasing government bonds.

That poses a problem, not just because Japan is faced with weak world trade and a slowing Chinese economy, but because other central banks cutting rates is likely to put upward pressure on the yen, reducing the value of foreign earnings for Japanese companies and potentially hitting the country’s exports.

The BOJ may still have some low-caliber ammunition left in its arsenal: extending its guidance to promise lower interest rates for longer, for example. Gov. Haruhiko Kuroda insists the BOJ can cut interest rates further, but with commercial banks already screeching about eroding interest margins, any further reduction would be cosmetic at most. Even the central bank itself no longer believes it can hit its inflation target, with its own forecasts suggesting prices won’t rise at the 2% rate it aims for at all during the next three years.

BOJ Gov. Haruhiko Kuroda insists the BOJ can cut interest rates further.


Andrew Harrer/Bloomberg News

Restarting the mammoth government bond purchases of 2012-2016 would have a diminished impact this time around, with yields already pinned at around 0% by the BOJ’s yield-curve control policy. And the central bank already owns nearly half of the total amount outstanding, and its policies have all but killed off activity elsewhere in the market.

The BOJ could try truly unconventional policies, like Milton Friedman’s helicopter money: putting cash directly in the hands of consumers, rather than swapping government bonds for bank reserves as conventional quantitative easing does.

But despite the fact that the country’s economic challenges are so entrenched, the institutional conservatism of the country’s economic policy makers makes such a shift unlikely.

The simplest move, and the one with the least damaging side effects would be for Prime Minister Shinzo Abe and Finance Minister Taro Aso to restring the second arrow of Abenomics: activist fiscal policy.

They appear primed to do the opposite: In October, Mr. Abe is set to implement an ill-advised increase in Japan’s sales tax to 10% from 8%. After decades of near-nonexistent inflation, such hikes are highly noticeable for consumers. The last one in 2014 pushed Japan back into recession.

Having just run in an election on a platform of raising the tax rate, Mr. Abe is unlikely to reverse now. Next time a real downturn approaches, the country will have to reconsider its overburdened monetary policy, and prepare its own fiscal stimulus.

Write to Mike Bird at Mike.Bird@wsj.com

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