Shifting central bank policies will provide lessons for all

Ever since the great recession of 2008, central banks have had to re-evaluate their policy objectives. Now, countries are taking strikingly different paths, and these disparate measures are causing lots of volatility in financial markets.

In Japan, the policy shift has been driven by the government elected last month, as well as the failure of past policies. The Bank of Japan targets inflation at 1 per cent, but the country has been experiencing deflation for much of the past four years. The latest inflation reading is minus-0.2 per cent.

News reports suggest that the Bank of Japan will raise its inflation target to 2 per cent. With interest rates already near zero, the central bank would have to implement other easing measures, such as increased asset purchases or money supply, to reach that target.

The new government has also been suggesting that the central bank's goal should be expanded to include job-creation targets.

Expectations of further monetary measures from Japan have been a key factor in the depreciation of the yen. The currency has weakened by more 13 per cent in the past four months, moving from 77.5 to the US dollar to above 89.5.

More aggressive monetary policies, and a labour-market target, would be similar to recent initiatives by the United States' Federal Reserve System.

Ever since 2008, the Fed has been one of the most forceful central banks in using monetary policy to stimulate growth. It has introduced huge programmes such as quantitative easing (QE), a fancy name for printing money, and Operation Twist to keep interest rates low across the bond curve. Last month, the Fed also, for the first time, explicitly linked its monetary policy to a target unemployment rate of 6.5 per cent. The current level is 7.8 per cent.

Recently, market expectations on Fed policy have been fluctuating. The Fed's meeting last month and its new unemployment target appeared to set the stage for loose monetary policy for years to come. However, reports this month also surprisingly suggest that the Fed is already starting to consider when to end its latest easing programme, QE3.

This news has provided support to the US dollar in foreign-exchange markets - though this factor may be temporary. Regardless of the exact end-date of QE3, the US will still be faced with low interest rates and relatively loose monetary policy for years to come.

There also remains a lot of uncertainty on upcoming debt-ceiling talks, especially with no "trillion-dollar coin" coming to the rescue.

The European Central Bank remains the most traditionally minded among its peers. Despite the threat of another recession in the euro zone, the ECB kept its policy interest rate unchanged at 0.75 per cent at its meeting early this month. It also surprised some investors by not providing any signals on future rate cuts.

While this may be disappointing from a short-term-growth perspective, the conservative nature of the ECB's policy has helped boost the euro in currency markets. In spite of the deep economic problems in Europe, the euro has risen to a seven-month high at around 1.34 to the dollar, and could see further support ahead, at least until the next financial crisis in the euro-zone periphery.

Hidden away by news elsewhere has been the Bank of England, but its policy debates may ultimately have the biggest implications of all. The central bank's new governor has been talking about replacing its inflation target with one for nominal gross domestic product.

GDP is usually adjusted for inflation so that analysts can calculate a "real" rate of growth. Nominal GDP is the unadjusted figure, which measures the total output of the economy. A nominal GDP target has been discussed in academia as a simplified way of reconciling growth and inflation targets. This could well be the next big thing in central banking.

It is now accepted that central banks need to be more flexible and forward-looking in their policy objectives. The very different policy paths taken by the major central banks will provide a storyline that other countries, including Thailand, can learn from. The success or failure of these policies will be fascinating to monitor in the year ahead.