Last updated: December 17, 2012 3:23 pm

Monetary policy moves to forefront in Japan

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There is nothing like finding someone to blame as a way of rallying support, and Shinzo Abe appears to have found a fine target in the Bank of Japan.

The Liberal Democratic party leader and prime minister-in-waiting made condemnation of what he sees as excessive central bank caution a central feature of campaigning ahead of the LDP’s sweeping election victory on Sunday.

Now Mr Abe has vowed to enlist the BoJ’s co-operation in fighting the twin curses of a high yen and persistent deflation.

He believes a more aggressive monetary policy would create inflation expectations and stimulate economic activity by encouraging Japan’s cash-rich businesses to invest their surplus funds rather than merely saving for an uncertain future.

To that end, he wants the BoJ to set an inflation target of 2 per cent and to undertake “unlimited” monetary easing to achieve that rate of price increase – which is twice as high as the BoJ’s current “goal” for consumer price inflation of 1 per cent.

But while the central bank expanded its asset purchase programme to a hefty Y91tn in October, it has resisted calls for more dramatic easing.

The BoJ’s argument has been that Japan already has extremely accommodative financial conditions – and that if companies and households are not spending, that is the result of government failure to provide enticing enough investment opportunities.

Masaaki Shirakawa, BoJ governor, said in a speech last month that to overcome persistent deflation, the government needed to launch decisive deregulation to make investing in Japan more attractive.

But Mr Abe believes more aggressive easing by the BoJ would also help to weaken the yen, which has weighed on Japanese exporters from Sony to Toyota.

Mr Abe is proposing the central bank join hands with the finance ministry and private investors to invest in foreign bonds through a public-private fund.

While Mr Abe has not elaborated on this proposal, the idea is presumably to get the BoJ to create money for investment in currencies such as the US dollar or Korean won, against which the yen has risen in recent years.

If the BoJ created enough money, the yen would weaken and prices would go up enough for Japan to exit deflation, says Robert Feldman, chief economist at Morgan Stanley MUFG Securities in Tokyo.

But such unconventional measures are not likely to go down well with the conservative BoJ, not least since they take the central bank deep into the realm of fiscal policy, and they could also be contentious internationally.

“The danger is that such a move would be seen by the outside world as currency intervention, a ‘beggar-thy-neighbour’ policy that would be against the rules,” says Masaaki Kanno, chief economist at JPMorgan in Tokyo.

Sceptics also fret that were the BoJ to freely create money to buy assets including government bonds, the result would be a damaging loss of fiscal discipline.

Still, even though the BoJ is guaranteed its independence under the Bank of Japan Act, Mr Abe may not need to revise the act to achieve his goals. Instead, he is expected to replace Mr Shirakawa, when his term expires in April, with a more dovish governor. The prime minister will also have the chance to nominate two like-minded deputy governors in March.

“It appears virtually inevitable that the new appointees will be sympathetic to the government’s calls for more aggressive easing,” says Ryutaro Kono, chief economist at BNP Paribas in Tokyo, in a report published on Monday.

As the political pressure mounts ahead of a two-day BoJ policy meeting that ends on Thursday, some analysts say the central bank may try to maintain a semblance of independence by pre-empting Mr Abe and raising its inflation goal to 2 per cent before it is forced to.

Mr Feldman says even if the central bank stands pat this week, further monetary easing is inevitable. “Whether or not the BoJ eases this week is not an issue, as it will have no choice but to ease going ahead anyway,” he says.

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