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Forex Flash: Japan’s monetary base already larger than that of US or UK - Nomura

FXstreet.com (Barcelona) - Richard Koo, Chief economist at the Nomura Research Institute notes that Japan’s monetary base already larger than that of US or UK.

He adds that Japan’s monetary base already amounted to 12% of GDP in 2000, compared with figures
of just 6.9% for the Eurozone and 5.9% for the US. After Lehman Brothers collapsed and the global financial crisis took hold, Koo notes that the Fed expanded the monetary base by 250%, the ECB by 57% and the BoE by 335%, but Japan, where the Shirakawa BOJ had already been increasing the supply of base money, still had a larger monetary base relative to GDP. In as muich as the quantitative easing programs undertaken by the US and the UK failed to bring the monetary bases in those countries to Japan-like levels when Masaaki Shirakawa was at the helm of the BOJ, Haruhiko Kuroda’s plan to increase the monetary base by another 100% naturally came as a surprise to observers outside the country.

Koo continues to recommend that simplistic comparisons should be avoided, however, since the size of the monetary base relative to GDP is greatly affected by people’s propensity to keep their savings in bank accounts. He writes, “Perhaps more importantly, a distinction must be drawn between the monetary base and the money supply, which represents money actually available for use by the general public. Only when base money flows out into the real economy and becomes part of the money supply can it be spent, boosting economic activity and inflation.”

Further, he notes that the statutory reserve requirement plays a key role in the transformation of base money into money supply. When the BOJ buys JGBs from private financial institutions, it deposits the money in their accounts at the BOJ, thereby expanding the monetary base. He adds that in Japan, the monetary base consists of currency and coins in circulation and current accounts at the BOJ, but as the latter also includes deposits from securities firms and money market dealers that are not required to hold reserves, the discussion below will focus only on reserve component of the deposits.

Also, he notes that Commercial banks seek to earn money by lending out those reserves, but they must keep a certain portion on deposit at the central bank in the form of statutory reserves. A statutory reserve ratio of 10%, for example, means banks can lend out 90% of their current account balances at the BOJ. When someone spends the money lent by a bank and the party receiving that money then deposits it somewhere else, the receiving institution can then lend out 90% of the new deposit to earn interest income (10% must be kept with the central bank as statutory reserves).

Koo sees that this process comes to a halt only when all the base money supplied by the BOJ has been lent and spent to become statutory reserves. At that point in time, commercial banks have on their books deposits and loans equal to ten times the reserve deposits injected by the BOJ (this multiple is the reciprocal of the 10% statutory reserve ratio and is referred to as the money multiplier). He writes, “Private-sector deposits at commercial banks represent money available for use by the private sector and are referred to as the money supply. The money supply also includes banknotes and coins, but in all modern economies bank deposits represent the lion’s share. Changes in the money supply have a major influence on economic activity and inflation.”

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