TOKYO (Reuters) - Setting an explicit cap on long-term interest rates, similar to one adopted by the Bank of Japan, won’t be an easy option for the U.S. Federal Reserve given the uncertainty around its impact on inflation expectations, a former BOJ executive said.
The BOJ now adopts a policy dubbed yield curve control (YCC) that combines a negative short-term rate target with an effective zero percent cap on 10-year government bond yields.
Faced with slowing growth and a lack of tools to battle the next recession, several top Fed officials have floated the idea of targeting longer-term rates just as the BOJ does now.
“There’s a risk that by capping long-term rates, central banks could hurt, not heighten, inflation expectations,” said Kazuo Momma, the BOJ’s former executive director who oversaw changes to monetary policy steps and international affairs.
He said keeping long-term rates low for a protracted period could risk stoking perceptions that inflation won’t rise much ahead.
Therefore, setting a yield cap won’t be an easy option for the Fed because of the uncertainty over its effect on inflation expectations, Momma told Reuters on Friday.
“Even if it does adopt one, the Fed will probably set a cap for the shorter end of the yield curve that’s easier to control,” said Momma, now executive economist at private think tank Mizuho Research Institute.
After years of heavy money printing, “there’s no magic hand left for central banks,” he said, adding that fiscal spending will be relied upon to play a bigger role in battling the next economic downturn.
Among major central banks, the BOJ has the least options left as years of radical stimulus measures have failed to achieve its 2 percent inflation target, Momma said.
If the economy slumps again, the BOJ may take minor steps such as modifying its forward guidance, or a commitment central banks make on future policy moves, he said.
In a forward guidance adopted in April, the BOJ said it will keep rates at current extremely low levels at least until around spring 2020.
“The BOJ could strengthen the forward guidance by binding it closer to inflation,” Momma said.
“For example, it could pledge to hold off on rate hikes until deflation risks are eradicated.”
Reporting by Leika Kihara; Editing by Shri Navaratnam