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The End of Independence for the Bank of Japan 

Neil Dwane 


Neil Dwane


Japan's imposition of yield-curve controls marks the moment that monetary policy became subservient to government policy. Neil Dwane says "fiscal dominance" is a dangerous successor to financial repression–not just for investors, but for economies too.
With its new policy of yield-curve control, the Bank of Japan (BOJ) has begun supplanting financial repression with "fiscal dominance." This essentially means that Japanese monetary policy will now be subservient to government policy, which will use domestic fiscal measures such as wage controls to create the necessary levels of inflation that have up to now been hard to manufacture.

With this move, Japan has all but ended the pretense of central-bank independence. If the practice of financing fiscal policy with monetary policy is successful, it will create inflation that erodes capital savings in many bond markets, it will endanger the purchasing power of retirement savings, and it will
If Japan’s new initiative is successful, it could create inflation that erodes capital savings and threatens global trade
threaten global trade by raising international tensions as currencies become more volatile again.

Will the world follow Japan's lead?

The BOJ’s recent changes are both a tacit admission that NIRP is not working and proof that Japan knows a new policy response is required to avoid a crushing classic recession. Japan's actions also move central-bank policy in a momentous new direction. The BOJ is promising to keep bond yields at their currently low levels while increasing the supply of yen into Japan’s economy until inflation meets or beats the BOJ's 2% target.

This sounds like continued financial repression but in reality it is much, much more. It will allow the Japanese government to fight the labor constraints of its ageing and shrinking population by implementing a "wages policy" that will mandate income and pay increases until inflation rises sufficiently.

The BOJ has raised the stakes in a dangerous game

With much debate at the Fed's latest Jackson Hole meeting about the policy responses needed to soften the inevitable US recession, the BOJ has substantially raised the stakes: It will be monetizing its government's financial needs at the expense of the yen. The Fed has admitted that it normally eases interest rates by approximately 5% during a recession, which it cannot do now. As such, it may resort to another significant bout of
Central banks now know that the longer QE lasts, the more it distorts economies and the harder it is to cease
quantitative easing (QE).

For its part, the European Central Bank (ECB) has already begun to reach the limits of its own monetary programs, and it may be forced to taper regardless of its willingness to lessen its support for the economy. Indeed, central banks globally now recognize that the longer QE lasts, the more it distorts markets and economies, and the harder it is to cease.

Investment implications

Clearly, we are migrating from a world of financial repression—where interest rates are held below stubbornly low inflation rates—to fiscal dominance, where the monetary policy of central banks becomes subservient to the solvency and fiscal requirements of
Although fiscal dominance is so far limited to Japan, it could have profound implications for investors elsewhere
their governments. This is a significant shift for many reasons:

  • As Japan heads down this path, the yen and Japanese government bonds will likely come under pressure. A weaker yen would likely help Japanese exporters, but the overall trend against globalization and free trade may ultimately work against them.

  • Although fiscal dominance is so far limited to Japan, it could have profound implications for investors elsewhere if other governments follow Japan's lead and ensure that their bonds no longer protect the purchasing power of savers.

  • Whether economies stick with financial repression or tilt toward fiscal dominance, this negative environment may persist for decades. As such, global economic growth will remain slow and low, and investors' returns will be driven by their appetite for accepting volatility and risk.

  • It continues to be important for investors to pursue alpha with active management, since beta returns are set to be low and volatile, which could undermine cheap index investments. And given the ongoing environment of volatility, investors should continue taking a close look at the risk-mitigation and diversification benefits that alternatives provide.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

Allianz Global Investors Distributors LLC, 1633 Broadway, New York, NY 10019-7585,, 1-800-926-4456.


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