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Japanese central bankers are of the more conservative variety. Stung by the bubble that gripped the country in the late 1980s, and two lost decades subsequently, officials turned increasingly cautious. Markets were thus duly impressed when the Bank of Japan apparently moved the dial in February, announcing an expansion of its asset purchases and a shift to inflation “goaling” – even if the latter falls short of the more explicit “targeting” practised elsewhere.
The stock market took the cue and rallied, while the currency, at long last, started to weaken, providing relief to policy makers and investors alike.
But the ride may not last. In the past few weeks, questions over the BoJ’s commitment to aggressively ease monetary policy have resurfaced. Even the governor himself, Masaaki Shirakawa, cautioned against increased bond purchases by the central bank. True, officials recently extended a lending programme designed to spur promising growth industries. But that is small fry. What really matters is whether the central bank eventually steps up asset purchases and expands its balance sheet. So far, there is little evidence of it.
The BoJ’s reservations are well known. Monetary policy, it is held, is ill-suited to raise the economy’s potential growth rate. When rates are already zero, and liquidity abundant, printing more yen would amount to pushing on a string. The only result, in fact, might simply be another asset bubble: more money, more problems.
No doubt, officials have a point. Extra cash is not a magic solution to Japan’s ills. But shying away from more aggressive action carries risks as well. Above all, such a U-turn in itself can undermine confidence. A central banker’s most valuable currency, after all, is credibility. After unveiling a decisive shift in its policy, the Bank of Japan needs to show it is serious about delivering on its stated goal. Otherwise, the hard fought gains in financial markets of late, including a weaker yen and livelier asset prices, may swiftly evaporate.
Whether monetary policy is the most effective tool to counter Japan’s challenges is, in this regard, almost secondary. Effective central banking hinges on expectations, and these need to be carefully nurtured. Even if a central bank ultimately fails to meet its goal, it must at least be seen trying to deliver. Actions, of course, speak louder than words. But in the world of central banking words also need to be adhered to for monetary policy to preserve its potency.
Three proposals spring to mind. First, the Bank of Japan could spread out its purchases of assets. So far, the central bank buys Japanese government bonds with up to two years’ maturity. This leaves markets wondering how far the central bank’s commitment really extends. As the bonds are repaid in short order, unless subsequently rolled over, the stimulus quickly fizzles. Announcing purchases of bonds with up to five years’ maturity would imply a more enduring boost. Stocking up on more risky assets, such as stocks, would further amplify the signal. Should things turn for the better in the meantime, the stimulus can always be withdrawn by other means.
Second, officials could clarify by when they intend to achieve their inflation goal. The timeframe matters hugely. So far, however, officials note that they aim for price stability merely over the “medium to long term”, with subsequent statements narrowing the range to a few years.
A harder goal of, say, two years would prove far more powerful. The timeframe, in fact, matters more than the actual goal, specified as 1 per cent for the time being, by providing firms, consumers, and investors with a measure for progress – even if it is ultimately missed.
Third, and to the BoJ’s point about the limits of monetary policy, a grand bargain could be struck with the government. In return for more aggressive structural reforms, including gradual tax increases, the central bank could promise meaningful relaxation of monetary policy. In this case, central bankers would at least be pushing on a string that is stiffened by improved economic fundamentals. Moreover, by raising tax rates over time, investors would take comfort that Japan’s vast bond market would not flounder once the BoJ ceases its purchases.
Central banking is tricky business. In recent years more so than usual. Japan faces a particularly vexing set of challenges. Deflation is entrenched, the population shrinking, and global uncertainties only compound local woes. Monetary policy is not a cure-all, but neither is it entirely impotent. The Bank of Japan has acted aggressively before, expanding its balance sheet in previous years with positive effects on prices and growth. Now is not the time to waver, even if recent green shoots have seemingly reduced the urgency for further easing. The Bank of Japan needs to follow its words with action. Nothing would please markets more. And the economy would ultimately be in better shape for it.
Frederic Neumann is co-head of Asian economics research at HSBC
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