LESS than a month after taking office as Japan’s new prime minister, Shinzo Abe has been lionised by some prominent Keynesians. His talk of curbing the independence of the Bank of Japan (BoJ) in order to strong-arm Japan out of deflation has won praise from those who think central banks may eventually need to sacrifice their autonomy and monetise government deficits in order to reflate their economies. Paul Krugman, a Nobel laureate and columnist for the New York Times, describes this as a “looking-glass realm” in which virtue is vice and prudence is folly. “Japan, of all places, seems to be the first government to figure that out,” he wrote on January 18th.
On January 22nd, however, the BoJ showed that there are limits to Mr Abe’s power. True, the central bank for the first time set a 2% inflation target and agreed to open-ended asset purchases, which marks a big capitulation; Mr Abe gushed about a “regime change” in economic policy. Yet on close inspection, the BoJ fought back as hard as it dared, reminding the markets how hard it is to launch an economic revolution in Japan’s consensual society.
It gave no indication that the new 2% “target” was any more reachable through monetary policy than the 1% “goal” it replaced, nor did it give a more meaningful time frame for achieving it than “at the earliest possible time”. The bank’s forecasts for the underlying consumer-price index in 2013 and 2014 (0.4% and 0.9%, respectively) barely changed from its previous assessment in October. Instead, the central bank appeared to put the onus on the government to hit the 2% target, through structural reforms designed to boost growth.
It dampened hopes of unlimited monetary easing to hit the new target. Its open-ended asset-purchase programme is not due to start until 2014. Even when it does, the size looks relatively puny compared with the ¥101 trillion ($1.14 trillion) of assets it already owns. The BoJ pledged to buy ¥13 trillion a month for an unlimited time; but when offset by redemptions, the net increase next year will be just ¥10 trillion, less than in both 2011 and 2012.
The bank even appears to have tried to tone down one of the other attention-grabbing measures of Mr Abe’s economic policy, that of unbridled fiscal stimulus. A joint government-BoJ statement talked little of stimulus and instead echoed the central bank’s long-held belief that public finances should be set on a more sustainable footing.
Financial markets, after a bit of initial confusion, reacted as if doused by a bucket of cold water. The currency, which Mr Abe’s jawboning had helped push down to a 31-month low—below 90 against the dollar—in a bid to revive the export industry, gained a little. The stockmarket this week suffered its first three-day losing streak since the general election was called on November 14th.
Many Japan specialists believe aspects of “Abenomics”—as Mr Abe’s three-pronged promise for reflating the economy through monetary, fiscal and structural remedies is known—are valuable, and that the BoJ was churlish to fight its corner so vehemently. For two decades Japan has seen GDP and long-term interest rates drop as deflation has become entrenched and its debt mountain has grown (see chart). A co-ordinated fiscal and monetary push may be better medicine for fixing these long-term problems than either on its own.
Monetary easing alone does not boost GDP much if the private sector cannot be persuaded to borrow, so the government provides the missing demand via stimulus. The BoJ’s asset purchases guarantee that the financing for that stimulus will be available. Earlier this month the government unveiled a {Yen}10.3 trillion fiscal-stimulus package, which the BoJ reckons will help Japan to grow by 2.3% this fiscal year.
Mr Abe may soon regain the upper hand. On April 8th Masaaki Shirakawa’s term as governor of the BoJ ends, and the prime minister has said he will appoint a replacement with a “strong will to overcome deflation”. Nikkei, a financial newspaper, said recently that the favourite among market-watchers in Japan is Toshiro Muto, a former BoJ deputy governor who was once nominated to head the bank by Mr Abe’s Liberal Democratic Party. (His candidacy was blocked by a now emasculated opposition.) He told Bloomberg, a news agency, this week that no measure should be considered taboo in hitting the inflation target.
Some of the more ambitious ideas being floated, such as using the central bank to buy foreign-government bonds to help weaken the currency, would require changes to the BoJ law and cost a lot of political capital. What’s more, they might further annoy foreign governments already worried about the effect of a weaker yen on their own exporters. Japanese policymakers often shy away from such fights.
Even if Mr Abe’s leverage is not as strong as market participants had hoped, they should welcome some aspects of this week’s policy accord. The insistence, long promoted by the central bank, that structural reform is the best way to revive growth is now part of a government document whose progress will be reviewed at regular intervals by the prime minister, top members of his cabinet and the BoJ governor in Mr Abe’s newly formed Council on Economic and Fiscal Policy.
In the BoJ’s view, such reforms should include deregulation, trade agreements such as the Trans-Pacific Partnership, and the greater use of women and elderly folk in an ageing workforce. Mr Abe promises to have such a growth strategy mapped out by mid-year, but he may be hesitant to pursue the most controversial ideas because of an upper-house election that he hopes his ruling block will win in July. Now that he shares responsibility for hitting a 2% inflation target in a country that has rarely come close to that in the past several decades, he cannot afford to linger.
Source: The Economist
