Thread by @marcgayle

What does this mean?

Per @J_Skally’s request I will attempt to “ELI5” (Explain Like I’m 5).

The way modern economies work is that the Central Bank 🏦 controls the amount of money in the financial system.

They have many tools. One is the “key policy rate”.

#FinanceTwitterJa

https://twitter.com/centralbankja/status/1443693393608159234

The Central Bank (CB) is the bank for all banks and other financial institutions.

When you deposit cash at Bank A, a chunk of that cash is deposited at the CB in the account for Bank A.

The CB also tells all the banks how much of their deposits…

they need to store with them.

When Bank A deposits cash with the CB, the CB pays Bank A interest according to their “key policy rate”.

Bank A also takes your deposits and lends them out. They lend them out as credit cards, mortgages, various loans, etc.

All of those lending products, their interest rate that they charge you is based on the rate that the CB gives them.

The lower the rate the CB pays, the lower rate they can charge on mortgages, credit cards, etc.

The higher the rate that the CB charges, is the more cash that banks deposit at the CB because that interest is basically risk-free.

So, if the CB wants to reduce the amount of cash in the system, then all they simply have to do is pay higher interest.

Conversely, when they want to increase the amount of cash in the system, they reduce the rate. Banks have less desire to park their cash there, because they want their money to earn money for them. So they increase the amount they actually lend.

Why would they want to increase the amount of cash in the system?

Because they want to encourage economic growth. The more cash in the system, is the more banks cut interest rates for mortgages which increases the amount of people that buy houses.

The lower credit card interest rates are is the more likely consumers are to purchase stuff.

Companies also have access to cheaper credit so they can invest in inventory, expansion projects, acquisitions, etc.

New construction happens more. We have seen this in JA.

JA feels like it has been flooded with all sorts of new real estate projects. From infrastructure done by the govt (roads, etc.), to residential & commercial real estate of all kinds.

We see 🏗 everywhere.

A lot of that has been enabled by low interest rates.

The downside to “cheap” money is that when more money is chasing the same amount of goods and services, then the price of those goods and services increase.

This is called inflation.

Some inflation is good.

BOJ targets 4% - 6% per year.

That’s because we want GDP growth.

But if inflation gets too high, it can be destructive.

See a great thread about inflation from @Julianinvests_ below 👇🏽

https://twitter.com/julianinvests_/status/1441725610473164801

BOJ has an inflation target range of 4% - 6%.

Over the last few quarters it has stayed within the range, but in recent months it has been trending up.

So because inflation broke the top band in August 2021 at 6.1%, and BOJ is concerned that it there is now an upward trend 📈

they have decided to “drain liquidity” from the system.

In other words, they are pulling cash out of the financial system by making it more attractive for banks to give them their cash rather than lending it consumers.

So the less cash in the hands of consumers and business..

is the less cash chasing the same goods and services, which eases pressure on prices.

Another key aspect to all of this is the impact on the FX market.

The more JMD that exists in the system, is the more demand created for FX all other things being equal.

So with this recent action, BOJ is both increasing the interest rate (which increases the cost of all credit products throughout the economy) and also generally reducing the amount of JMD in the system.

So, in summary, BOJ is attacking inflation on multiple fronts:
- Reducing credit in the entire system (by reducing its key rate)
- Reducing JMD available to banks generally
- Reducing pressure on the JMD in FX markets by reducing JMD in the system.

So the likely impact of this policy action is that all credit based financial products will become more expensive over time (ie mortgage, credit card, unsecured loans, etc. interest rates will increase over time).

If BOJ keeps raising rates, it could slow down GDP growth generally as less projects are funded and the cost of credit increases.

Construction could slow down.

That being said, this is just the first increase, so the negative repercussions may not materialize for now.

Hope this thread helped someone.

Another consideration to think about, if you have a loan (mortgage, etc.) that has a variable interest rate, you could see your interest rate increase in the near future.

Keep an eye on your credit card statements over the coming months!