Has the Bank of Japan succeeded or failed? The answer is both: unemployment is strikingly low, which indicates that its monetary policy has worked; but inflation is still far below its 2 per cent target, which indicates it has not. There is still no justification for monetary tightening. But additional policy options need to be considered.
How is the Japanese economy performing? In its October forecasts, the IMF set the “output gap” — the margin of unused capacity — at near zero. The rate of unemployment is at its lowest since 1992, at 2.4 per cent in October. This is low indeed: unemployment did not fall below 2 per cent even at the peak of the “bubble economy”. The unemployment rate has also fallen by 1.8 percentage points since the inflation target was raised to 2 per cent, in early 2013.
If the Bank of Japan’s aim had been mainly to eliminate cyclical slack, its policy must be judged successful. But it is not. Year-on-year consumer price inflation, without energy and food, is still well below target, at a mere 0.4 per cent in the year to October. It has averaged just 0.2 per cent over the past two years. Deflation may be over. But inflation has not taken its place, nearly six years after the higher target was set.
Moreover, worries are emerging about the strength of the economy, after contraction in the third quarter. Yet most analysts believe this was due to a series of natural disasters. The latest Tankan survey of large manufacturers also shows no weakening. In its latest Economic Outlook, the OECD forecasts growth of 0.9 per cent this year and 1 per cent in 2019, in line with Japan’s low potential. For the real economy, the challenge is more structural than cyclical, and so beyond the reach of monetary policy.
Yet it is still puzzling that such an extreme monetary policy, which has seen the assets of the BoJ rise to an extraordinary level of 100 per cent of gross domestic product, has had so limited an effect on inflation. One reason is that it has not led to overheating of the economy. Another is that the exchange rate against the US dollar has actually appreciated since 2015. A still more important reason must be that inflation expectations became so stubbornly anchored at close to zero.
So what is to be done? One possibility might be to abandon the attempt to raise inflation. But that would be a serious error. It would be bad for credibility if the authorities failed to hit such firmly announced objectives. It would be even worse if Japan were to enter the next recession with inflation stuck so close to zero. This would make dealing with such a situation very difficult.
Despite all the obstacles, the BoJ must keep plugging on with a combination of asset purchases and yield management. It might have to move the short-term rate even further into negative territory. Provided it can keep the economy running consistently hot, it has a reasonable chance of raising inflation towards the target.
At the same time, it will probably need more help from the government. The proposed increase in the consumption tax in October of next year needs to be abandoned until the inflation target is reached. Indeed, the idea that the best target for increased taxation is consumption makes no sense in a country with such exceptionally low shares of consumption in GDP. It would be far better to tax something else, such as undistributed and uninvested profits. It is also possible that explicit resort to “helicopter money” will be required. The aim now should not just be for the BoJ to keep carrying on, but for the government to co-operate fully with it, to lift Japan out of its deflation trap.
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