## _wp10114

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### I. Introduction
- Central banks in advanced economies adopted unconventional monetary policies during the global crisis with differing instruments and focus:
  - U.S. Federal Reserve: “credit-easing” measures that changed the size and composition of its balance sheet.
  - European Central Bank: extended refinancing operations and acquired covered bonds for “enhanced credit support”.
  - Bank of England: “quantitative easing” (QE) operations featuring outright purchases of gilts and some corporate debt.
- Common motivations and exit concerns:
  - Provide additional monetary stimulus and stabilize financial markets when policy rates were near the zero bound.
  - Exit management received attention as economies recovered; early unwinding examples:
    - December 2009: ECB stopped lending banks unlimited 1-year funds.
    - February 2010: BoE paused its gilt purchases.
    - March 2010: Fed terminated purchases of mortgage-backed securities and agency debt.
  - Exit risks include disorderly unwinding, undermined credibility/independence; stabilizing market expectations via communication strategies is important.
- Key policy questions:
  - Appropriate sequence of exit and modalities, including whether interest rates can be raised before fully unwinding unconventional measures.
  - Effective communication of exit strategy and policy stance.
  - Management of potential losses to central bank balance sheets.
  - Whether monetary policy frameworks should revert to precrisis forms or be changed.

### II. The BoJ’s Unconventional Measures (context and tools)
- Crisis context and range of channels when policy rates hit the lower bound:
  - Providing funds to financial institutions to alleviate liquidity concerns.
  - Purchasing assets with longer-term maturities (e.g., long-term government bonds).
  - Intervening in credit markets by purchasing private assets or providing loans collateralized by private-sector assets.
  - Guiding longer-term interest rates by committing to keeping policy rates low for an extended period.
- BoJ actions and balance sheet evolution:
  - Zero interest rate policy (ZIRP, February 1999–August 2000) maintained overnight rates at virtually zero.
  - QE period: March 2001–March 2006 — BoJ changed operating target to outstanding balance of banks’ current accounts at the central bank, with reserves far above required levels.
  - At peak, BoJ’s balance sheet exceeded ¥150 trillion, or around 30 percent of GDP.
  - Outright JGB purchases increased from ¥400 billion to ¥1.2 trillion per month during QE.
  - November 2002: program to purchase bank stockholdings.
  - July 2003: ¥1 trillion scheme for outright purchases of asset-backed securities (ABS) and asset-backed commercial paper (ABCP).
  - Policy-duration commitment: BoJ announced continuation of QE until actual inflation became stably nonnegative.
  - BoJ’s assets grew from ¥91 trillion in 1998 to about ¥155 trillion in 2006, or from 18 to more than 30 percent of GDP.
  - Of the increase, about three-fifths came from enhanced liquidity-supplying operations; the rest mainly from long-term JGB purchases; nonconventional asset purchases were negligible.
  - On the liabilities side, buildup was matched almost entirely by bank reserves.

### III. The BoJ’s Exit Strategy: theory and practical complications
- Theoretical exit operations:
  1. Halting extraordinary interventions.
  2. Downsizing and normalizing the central bank balance sheet.
  3. Selling purchased assets, if necessary.
  4. Raising short-term interest rates.
- Practical complications:
  - Uncertainties about activity, inflation outlook, and transmission mechanisms complicate timing, pace, and sequencing.
  - Returning to a positive policy rate usually requires elimination or neutralization of excess bank reserves accumulated through unconventional operations.
  - Some excess reserves contract automatically as emergency facilities end and short-lived assets mature; others require selling assets or sterilization tools (e.g., paying interest, issuing central bank bills).

### IV. BoJ’s practical exit actions and experience
- Overview of BoJ exit sequencing and timing:
  - Although recovery began in 2002, BoJ ended QE in March 2006.
  - BoJ signaled exit by announcing gradual liquidity drainage while keeping the overnight rate at virtually zero; by July 2006 it transitioned to a more normal framework, having downsized its balance sheet before raising the policy rate.
  - Factors aiding orderly exit: clear communication, transparent conditions for future actions, flexibility, market confidence in liquidity-absorption tools, revival of risk appetite through restructuring of financial/debtor balance sheets, and prudence/safeguards during entry.

- A. Exit from Liquidity Operations and JGB Purchases
  - Balance sheet contraction:
    - BoJ’s balance sheet shrank from ¥145 trillion to ¥116 trillion between March and July 2006.
    - The decline largely reflected a ¥20 trillion decrease in funds-supplying operations and natural unwinding of short-dated securities.
    - BoJ did not need to increase issuance of its own bills to sterilize reserves because reserves contracted smoothly.
  - Exit announcement and approach:
    - Reduction of excess reserves would be achieved via adjustments in short-term money market operations without immediate reduction of JGB holdings.
  - Two main contributors to smooth normalization:
    - Increase in BoJ’s balance sheet was largely due to ordinary operations; short-term liquidity operations unwound naturally as they provided funds at a premium over the policy rate and were withdrawn by allowing short-term assets to mature. The average maturity of these bills fell to four months in Q1 2006.
    - Discipline in outright JGB purchases via a “banknote rule” requiring long-term government bond holdings to remain below banknotes in circulation, capping JGB purchases as an exit safeguard.
  - Incomplete exit aspects:
    - BoJ had not reduced outright JGB purchases and, in response to the current crisis, purchases were increased to ¥1.8 trillion per month.
    - At end-March 2010 BoJ’s holdings of government securities stood at ¥73 trillion, or around 15 percent of GDP.

- B. Exit from the Policy Duration Commitment: Raising Interest Rates
  - Challenge: markets expected near-zero rates for an extended period, creating a kink in the yield curve.
  - Smooth exit scenario: market expectations about duration are gradually shortened (kink shifts closer to origin) before rate hikes shift the yield curve upward.
  - Drastic exit scenario: market cannot adjust smoothly and yield curve moves up abruptly, potentially disrupting activity.
  - BoJ’s conditional commitment and communication:
    - Commitment made conditional on an observable statistic: actual CPI inflation.
    - October 10, 2003: BoJ announced a “More Detailed Description of the Commitment to Maintaining the Quantitative Easing Policy,” introducing two “necessary conditions” for exit:
      1. “it required not only that the most recently published core CPI should register a zero percent or above, but also that such tendency be confirmed over a few months”;
      2. “many Policy Board members need to make the forecasts that the core CPI will register above zero percent during the forecasting period.”
    - BoJ published an “Interim Assessment” in January and July in addition to regular Outlook Reports in April and October, and used speeches and press conferences to express near-term prospects for short-term interest rates.

- C. Exit from Unconventional Asset Purchases (ABS, ABCP, stocks)
  - Exit from ABS and ABCP purchase schemes:
    - Sunset clauses: schemes were clarified to terminate in March 2006; markets expected termination, reducing need for further exit announcements.
    - Bidding for ABS was negligible (only ¥1 billion) once the economy started to recover.
    - Total amount purchased remained substantially below the ¥1 trillion cap on the program.
    - Amounts outstanding at the BoJ declined smoothly as the purchased ABCP matured.
    - BoJ published the range and the median of board members’ inflation outlook in its Outlook Reports, allowing market participants to infer the distribution of board members’ views.
    - Example remark by Governor Fukui on March 16, 2006, described a period of effectively zero percent uncollateralized overnight call rate followed by a gradual adjustment if inflationary pressures remained muted.
  - Exit from stock purchases:
    - Entry-stage safeguards:
      - Total amount available for stock purchases limited to ¥3 trillion.
      - Eligibility constrained to stocks held by banks whose stockholdings exceeded their Tier I capital.
      - Included a sunset clause (September 2003, later extended to September 2004).
    - Exit-stage measures:
      - BoJ announced explicit “selling guidelines” in July 2007.
      - Delegated sales to trustees (trust banks) with attention to diversifying timing to minimize stock market impact.
      - Trustees allowed to temporarily postpone sales in the event of a substantial decline in stock prices.
      - Selling process began after October 2007 with a 10-year targeted completion date, but the process was halted in October 2008 as global stock markets collapsed.

### V. New monetary framework and communication after exit
- Motivation and framework (published March 9, 2006):
  - Announced policy board members’ “understanding of price stability” as annual CPI inflation of between 0 and 2 percent.
  - Emphasized forward-looking orientation with two perspectives:
    - Outlook for growth and prices one to two years ahead.
    - Longer-term examination of various risks (e.g., asset price bubbles or excessive credit expansion) that could undermine price and output prospects.
  - Enhanced communication: monetary policy decisions explained in terms of the two perspectives and underlying analysis discussed in semiannual Outlook Reports and Interim Assessments.

### VI. Assessment: successes, shortcomings, and empirical communication effects
- Positive outcomes:
  - Possible to exit from QE smoothly without overshooting inflation, derailing recovery, or destabilizing financial markets.
  - BoJ reduced its balance sheet and excess bank reserves within a few months after termination of QE, although not fully back to late-1990 levels.
  - No evidence of abrupt portfolio shifts or heightened volatility in safe and risky assets.
  - Gradual unwinding of JGB holdings saw yields rise by only about 35 basis points.
  - QE did not unleash dangerous inflationary pressures.
- Communication effects:
  - Empirical studies detect policy duration effects until the beginning of 2005; policy duration effect decreased thereafter, falling to almost zero before the BoJ’s exit in March 2006.
  - Policy duration commitment was not an obstacle to BoJ’s raising of overnight interest rates in July 2006, as markets had built the rate hike into expectations.
- Shortcomings:
  - Persistently weak price environment after exit; BoJ was only able to raise policy rates to 0.5 percent, and after the “Lehman Shock” in 2008 BoJ entered another easing phase.
  - Exit remains incomplete to some extent given BoJ’s continued holding of stocks and JGBs.

### VII. Potential implications and lessons for current exits
- Broad principles drawn from Japan’s experience:
  - Ensure the central bank has sufficient tools to facilitate the unwinding of unconventional monetary policy; a wide range of instruments can boost market confidence that exit can be effectively managed.
  - Tailor unwinding to specific characteristics of purchased assets:
    - Assets with short maturities (e.g., ABCP) can often be held to maturity as risk appetite recovers.
    - Assets with longer maturities (e.g., JGBs and stocks) may need formal “selling strategies” and effective safeguards introduced at the time of purchase to facilitate eventual unwinding.
  - Unwinding long-maturity or shallow-market assets is more challenging due to potential market impact and central bank losses:
    - Private asset purchases during crises are typically at fire-sale prices, so holding to maturity or selling later may entail low loss risk, but risks remain where markets are impaired or volatile, or where holding long-dated bonds carries interest rate risk as the economy recovers.
    - Central banks should refrain from announcing profit maximization as an objective when selling assets, to avoid signaling that prices have peaked.
  - Communication is crucial:
    - Unconventional easing involves varied measures with uncertain transmission; exit will take more time than ordinary tightening operations.
    - Central banks typically need to begin unwinding policy duration commitments before raising rates and must guide expectations by effectively communicating assessments of outlook and risks.
    - More frequent assessments and conditional commitments of policy duration can help smooth exit.
  - Post-exit challenges:
    - Central banks may need to revisit monetary policy frameworks to incorporate additional risks highlighted by crises (e.g., from financial markets and asset prices), as illustrated by the BoJ’s new two-perspective approach.

*Content extracted from _wp10114 - References .............................................................................................................*

### References .............................................................................................................

### References

### I. INTRODUCTION
- Central banks in advanced economies adopted unconventional monetary policies during the global crisis, with differing focus and instruments:
  - U.S. Federal Reserve: dramatically changed the size and composition of its balance sheet through “credit-easing” measures aimed at stabilizing credit markets.
  - European Central Bank: extended refinancing operations and acquired covered bonds to provide “enhanced credit support”.
  - Bank of England: “quantitative easing” (QE) operations featuring outright purchases of gilts and some corporate debt.
- Common motivation: provide additional monetary stimulus and stabilize financial markets when policy rates fell close to their zero bound.
- As economies emerge from the Great Recession, exit management gained attention:
  - Examples of early unwinding and testing of draining tools:
    - December 2009: ECB stopped lending banks unlimited 1-year funds.
    - February 2010: BoE paused its gilt purchases.
    - March 2010: Fed terminated purchases of mortgage-backed securities and agency debt (Sack, 2010; and Trichet, 2009).
- Exit risks include disorderly unwinding or actions that could undermine central bank credibility and independence; stabilizing market expectations via communication strategies is important.
- Historical precedent: Bank of Japan (BoJ) in the wake of a similar financial crisis nearly 10 years earlier pioneered unorthodox monetary policies and executed a relatively smooth exit as the economy recovered (Shirakawa, 2009a and 2009b).
- Note focus: technical aspects, practicalities, and communication strategies of exit (not timing).
- Key policy questions highlighted:
  - What is the appropriate sequence of exit and considerations for modalities, including whether interest rates can be raised before fully unwinding unconventional measures?
  - What is the most effective way of communicating the central bank’s strategy and policy stance during the exit?
  - How can potential losses to central bank balance sheets be managed?
  - Should monetary policy frameworks revert to precrisis forms or are changes warranted?

### II. REWRITING THE RULES: THE BOJ’S UNCONVENTIONAL MEASURES
- Context:
  - Japanese economy faced a crisis similar to the Great Recession; BoJ adopted unorthodox measures between late 1990s and mid 2000s when policy rates were at the zero bound (Syed, Kang, and Tokuoka, 2009).
- Channels for additional stimulus when rates hit the lower bound:
  1. Providing funds to financial institutions to alleviate liquidity concerns.
  2. Purchasing assets with longer-term maturities (e.g., long-term government bonds).
  3. Intervening directly in credit markets by purchasing private assets or providing loans collateralized by private-sector assets.
  4. Guiding longer-term interest rates by committing to keeping policy rates low for an extended period.
- BoJ’s measures covered the full spectrum:
  - Massive liquidity provision and QE:
    - Conventional open-market operations extended to broader participants, longer maturities, wider collateral.
    - Zero interest rate policy (ZIRP, February 1999–August 2000) maintained overnight rates at virtually zero.
    - During QE (March 2001–March 2006) BoJ changed operating target to outstanding balance of banks’ current accounts at the central bank, with reserves far above required levels (Figure 1).
    - At peak, BoJ’s balance sheet exceeded ¥150 trillion, or around 30 percent of GDP.
  - Outright purchases of long-term government bonds:
    - BoJ increased outright JGB purchases from ¥400 billion to ¥1.2 trillion per month during QE.
  - Outright purchases of assets with credit risks:
    - November 2002: program to purchase bank stockholdings.
    - July 2003: ¥1 trillion scheme for outright purchases of asset-backed securities (ABS) and asset-backed commercial paper (ABCP).
  - Policy duration commitment:
    - BoJ announced it would continue QE until actual inflation became stably nonnegative.
- Balance sheet evolution and composition:
  - BoJ’s assets grew from ¥91 trillion in 1998 to about ¥155 trillion in 2006, or from 18 to more than 30 percent of GDP (Figure 2).
  - Of the increase, about three-fifths came from enhanced liquidity-supplying operations, the rest mainly from long-term JGB purchases; nonconventional asset purchases were negligible.
  - On the liabilities side, buildup was matched almost entirely by bank reserves.

### III. THE BOJ’S EXIT STRATEGY
- Theoretical operations for exit:
  1. Halting extraordinary interventions.
  2. Downsizing and normalizing the central bank balance sheet.
  3. Selling purchased assets, if necessary.
  4. Raising short-term interest rates.
- Practical complications:
  - Uncertainties about activity, inflation outlook, and transmission mechanisms complicate timing, pace, and sequencing.
  - To return to a positive policy rate, central banks usually need to eliminate or neutralize excess bank reserves accumulated through unconventional operations.
  - Some excess reserves contract automatically as emergency facilities end and short-lived assets mature; others require selling assets or sterilization tools (e.g., paying interest, issuing central bank bills).
- BoJ’s experience:
  - Although recovery began in 2002, BoJ ended QE in March 2006.
  - BoJ signaled exit by announcing gradual liquidity drainage while keeping the overnight rate at virtually zero; by July 2006 it transitioned to a more normal framework, having downsized its balance sheet before raising the policy rate.
  - Factors aiding an orderly exit: clear communication, transparent conditions for future actions, flexibility, market confidence in liquidity-absorption tools, revival of risk appetite through restructuring of financial/debtor balance sheets, and prudence/safeguards during entry.
- A. Exit from Liquidity Operations and JGB Purchases
  - Balance sheet contraction:
    - BoJ’s balance sheet shrank from ¥145 trillion to ¥116 trillion between March and July 2006.
    - The decline largely reflected a ¥20 trillion decrease in funds-supplying operations and natural unwinding of short-dated securities.
    - BoJ did not need to increase issuance of its own bills to sterilize reserves because reserves contracted smoothly.
  - BoJ’s exit announcement clarified reduction of excess reserves would be achieved via adjustments in short-term money market operations without immediate reduction of JGB holdings.
  - Two main contributors to smooth normalization:
    - Increase in BoJ’s balance sheet was largely due to ordinary operations; short-term liquidity operations unwound naturally as they provided funds at a premium over the policy rate and were withdrawn by allowing short-term assets to mature. The average maturity of these bills fell to four months in Q1 2006.
    - Discipline in outright JGB purchases via a “banknote rule” requiring long-term government bond holdings to remain below banknotes in circulation, capping JGB purchases as an exit safeguard.
  - Despite these safeguards, BoJ had not reduced outright JGB purchases and, in response to the current crisis, purchases were increased to ¥1.8 trillion per month; exit remained incomplete on this front.
  - At end-March 2010 BoJ’s holdings of government securities stood at ¥73 trillion, or around 15 percent of GDP.
- B. Exit from the Policy Duration Commitment: Raising Interest Rates
  - Ending the policy duration commitment posed major challenges because markets expected near-zero rates for an extended period, creating a kink in the yield curve (Figure 3).
  - Smooth exit scenario: market expectations about duration are gradually shortened (kink shifts closer to origin) before rate hikes shift the yield curve upward.
  - Drastic exit scenario: market cannot adjust smoothly and yield curve moves up abruptly, potentially disrupting activity.
  - BoJ made the commitment conditional on an observable statistic: actual CPI inflation, so improvements in inflation outlook would help shorten the policy duration effect.
  - October 10, 2003: BoJ announced a “More Detailed Description of the Commitment to Maintaining the Quantitative Easing Policy,” introducing two “necessary conditions” for exit:
    1. “it required not only that the most recently published core CPI should register a zero percent or above, but also that such tendency be confirmed over a few months”;
    2. “many Policy Board members need to make the forecasts that the core CPI will register above zero percent during the forecasting period.”
  - BoJ enhanced communication by publishing an “Interim Assessment” of economic developments in January and July, in addition to regular Outlook Reports in April and October, and through speeches and press conferences where officials expressed near-term prospects for short-term interest rates.
- C. Exit from Unconventional Asset Purchases
  - (Content for this subsection begins but is not included in the supplied text.)

*Italic: Content extracted from _wp10114 - References .............................................................................................................*

### 16.      The BoJ was able to smoothly exit from its ABS and ABCP purchase schemes,

### _wp10114 - 16.      The BoJ was able to smoothly exit from its ABS and ABCP purchase schemes,

### Exit from ABS and ABCP purchase schemes
- Sunset clauses:
  - Schemes were clarified to terminate in March 2006.
  - Market participants expected termination due to the sunset clause, reducing need for further exit announcements.
  - Markets stabilized from 2002 onwards, lowering the need to extend the schemes.
- Short maturities and financial restructuring:
  - Bidding for ABS was negligible (only ¥1 billion) once the economy started to recover.
  - Total amount purchased remained substantially below the ¥1 trillion cap on the program.
  - Amounts outstanding at the BoJ declined smoothly as the purchased ABCP matured.
- Communication linkage:
  - The BoJ published the range and the median of board members’ inflation outlook in its Outlook Reports, allowing market participants to infer the distribution of board members’ views.
  - Example remark by Governor Fukui on March 16, 2006, described a period of effectively zero percent uncollateralized overnight call rate followed by a gradual adjustment if inflationary pressures remained muted.

### Exit from stock purchases
- Entry-stage safeguards to limit market disruption and BoJ balance-sheet risks:
  - Total amount available for stock purchases limited to ¥3 trillion.
  - Eligibility constrained to stocks held by banks whose stockholdings exceeded their Tier I capital.
  - Included a sunset clause (September 2003, later extended to September 2004).
- Exit-stage measures:
  - BoJ announced explicit “selling guidelines” in July 2007.
  - Delegated sales to trustees (trust banks) with attention to diversifying timing to minimize stock market impact.
  - Trustees allowed to temporarily postpone sales in the event of a substantial decline in stock prices.
  - Selling process began after October 2007 with a 10-year targeted completion date, but the process was halted in October 2008 as global stock markets collapsed.

### New monetary framework and communication after exit
- Motivation:
  - BoJ adjusted its monetary policy framework to incorporate lessons from the earlier bubble period and to provide a new anchor to guide expectations after QE ended.
- Framework published on March 9, 2006:
  - Announced policy board members’ “understanding of price stability” as annual CPI inflation of between 0 and 2 percent.
  - Emphasized forward-looking orientation of policy with two perspectives:
    - Outlook for growth and prices one to two years ahead.
    - Longer-term examination of various risks (e.g., asset price bubbles or excessive credit expansion) that could undermine price and output prospects.
  - Enhanced communication: monetary policy decisions explained in terms of the two perspectives and underlying analysis discussed in semiannual Outlook Reports and Interim Assessments.

### How successful was Japan’s exit?
- Positive outcomes:
  - Possible to exit from QE smoothly without overshooting inflation, derailing recovery, or destabilizing financial markets.
  - BoJ reduced its balance sheet and excess bank reserves within a few months after termination of QE, although not fully back to late-1990 levels.
  - No evidence of abrupt portfolio shifts or heightened volatility in safe and risky assets.
  - Gradual unwinding of JGB holdings saw yields rise by only about 35 basis points.
  - QE did not unleash dangerous inflationary pressures.
- Communication effects:
  - Empirical studies detect policy duration effects until the beginning of 2005; policy duration effect decreased thereafter, falling to almost zero before the BoJ’s exit in March 2006.
  - Policy duration commitment was not an obstacle to BoJ’s raising of overnight interest rates in July 2006, as markets had built the rate hike into expectations.
- Shortcomings:
  - Persistently weak price environment after exit; BoJ was only able to raise policy rates to 0.5 percent, and after the “Lehman Shock” in 2008 BoJ entered another easing phase.
  - Exit remains incomplete to some extent given BoJ’s continued holding of stocks and JGBs.

### Potential implications and lessons for current exits
- General observation:
  - Central banks in advanced economies have adopted many similar policies, with swollen balance sheets and mushrooming bank reserves; exit will be challenging though technically operations may seem manageable.
- Broad principles drawn from Japan’s experience:
  - Ensure the central bank has sufficient tools to facilitate the unwinding of unconventional monetary policy; a wide range of instruments can boost market confidence that exit can be effectively managed.
  - Tailor unwinding to specific characteristics of purchased assets:
    - Assets with short maturities (e.g., ABCP) can often be held to maturity as risk appetite recovers.
    - Assets with longer maturities (e.g., JGBs and stocks) may need formal “selling strategies” and effective safeguards introduced at the time of purchase to facilitate eventual unwinding.
  - Unwinding long-maturity or shallow-market assets is more challenging due to potential market impact and central bank losses:
    - Private asset purchases during crises are typically at fire-sale prices, so holding to maturity or selling later may entail low loss risk, but risks remain where markets are impaired or volatile, or where holding long-dated bonds carries interest rate risk as the economy recovers.
    - Central banks should refrain from announcing profit maximization as an objective when selling assets, to avoid signaling that prices have peaked.
  - Communication is crucial:
    - Unconventional easing involves varied measures with uncertain transmission; exit will take more time than ordinary tightening operations.
    - Central banks typically need to begin unwinding policy duration commitments before raising rates and must guide expectations by effectively communicating assessments of outlook and risks.
    - More frequent assessments and conditional commitments of policy duration can help smooth exit.
  - Post-exit challenges:
    - Central banks may need to revisit monetary policy frameworks to incorporate additional risks highlighted by crises (e.g., from financial markets and asset prices), as illustrated by the BoJ’s new two-perspective approach.

*Canonical source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2010/_wp10114.pdf*

---


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