The Bank of Japan (BOJ) has fully initiated the normalization process of its unconventional monetary policy. Can it "exit unscathed" this time? If successful, where will the end point of the BOJ's interest rate hikes and balance sheet reduction be? What impact will it have on Japanese government bond yields (curve), the yen exchange rate, and the economy?

I. The Evolutionary Context and Transmission Mechanism of the BOJ's Unconventional Policies

Since the implementation of the zero interest rate policy in 1999, the BOJ has been at the forefront of "experiments" in unconventional monetary policy. This section organizes its evolutionary path from three dimensions: price, quantity, and quality: (1) Interest rates mainly refer to the policy rate, i.e., the unsecured overnight call rate; (2) Quantity refers to the scale of reserves; (3) Quality refers to the risk premium, broadly referring to the entire yield curve.

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The zero interest rate policy in 1999 only covered the interest rate dimension; the Quantitative Easing Policy (QEP) in 2001 included three dimensions of interest rates, quantity, and quality, but the quality only included term premium and did not include risk premium; the Comprehensive Monetary Easing (CME) in 2010 also included three dimensions, but the quality dimension paid more attention to risk premium; the "QQE+" policy since 2013 has broken the boundaries of previous policies in all three dimensions of interest rates, quantity, and quality.

According to the Fisher equation, the effect of loose monetary policy will be reflected in the downward shift of the real interest rate (curve), and it can only be considered substantial loosening when it is below the natural interest rate (curve), thereby helping to improve financial conditions and economic recovery. As the output gap narrows, the economic foundation of inflation expectations is solidified, inflation translates from expectations to reality, and gradually achieves a virtuous cycle.

II. Effectiveness Assessment and Comparison of the BOJ's Unconventional Policies

How effective has the "QQE+" policy implemented by the BOJ since 2013 been? This section examines it from two aspects: (1) Financial conditions, such as the Japanese government bond yield curve, risk premium, yen exchange rate, etc., all of which are part of the transmission of monetary policy; (2) Nominal growth, including economic growth, inflation, or inflation expectations, that is, to what extent the loosening of financial conditions helps Japan escape long-term stagnation.

The "QQE+" policy has significantly improved Japan's financial conditions. It is estimated that since the QQE, the BOJ's purchase of government bonds has cumulatively reduced the 10-year Japanese government bond rate by about 100 basis points, achieving substantial monetary loosening. Driven by both risk-free interest rates and risk premiums, Japanese bank lending rates and corporate bond financing rates have continued to decline. The depreciation of the yen is another manifestation of the effect of monetary loosening.

The substantial loosening of financial conditions has helped Japan escape the "deflation trap." Quantitative research based on counterfactual reasoning (if the BOJ had not implemented the QQE+ policy) shows that since the implementation of the "QQE+" policy, Japan's real GDP level has increased by 0.9-1.3 percentage points, and the core-core CPI (all items except fresh food and energy) inflation rate has increased by 0.6-0.7 percentage points.

III. The BOJ's "Third Experiment" in Normalizing Unconventional PoliciesThe Bank of Japan (BOJ) has fully initiated the normalization process of unconventional policies. Looking ahead, determining the terminal interest rate, the appropriate balance sheet size, and the adequate scale of reserves are all "must-answer questions." In the March 2024 meeting, the BOJ officially fired the "first shot" in interest rate normalization: it eliminated negative interest rates, abandoned the QQE+YCC framework, and raised the target range for the overnight call rate from [-0.1%, 0%] to [0%, 0.1%]. In the July meeting, the BOJ raised interest rates again, with the target rate rising to around 0.25%, and indicated that further rate hikes would continue. According to the neutral interest rate framework—the BOJ estimates the actual neutral interest rate range to be approximately [-1%, 0.5%], with the nominal neutral policy rate matching the 2% inflation target at [1%, 1.5%].

In the July 2024 meeting, the BOJ fired the "first shot" in balance sheet normalization: (1)原则上每季减少约4000亿国债购买量，使其在2026年1-3月期间达到约3万亿；（2）2025年6月例会将进行中期评估，原则上还将继续缩表，但会按需修正；（3）灵活应对长期利率的上升；预计未来一年半，日央行持有的国债规模将减少7-8%，但存量效应仍起主导作用，或难成为日债利率上行的主线。

In the July 2024 meeting, the BOJ fired the "first shot" in the normalization of its balance sheet: (1) In principle, it will reduce the purchase of government bonds by about 40 billion yen each quarter, aiming to reach approximately 300 trillion yen during the January-March 2026 period; (2) A mid-term review will be conducted at the June 2025 meeting, and in principle, the balance sheet reduction will continue, but adjustments will be made as needed; (3) It will flexibly respond to the rise in long-term interest rates; it is expected that over the next year and a half, the scale of government bonds held by the BOJ will decrease by 7-8%, but the stock effect will still play a dominant role, and it may not become the main driver of the upward trend in Japanese government bond yields.