Japan risks repeating some old mistakes
The central bank is muddying its commitment to easy monetary policy
Robin Harding
In April 1997, Japan raised consumption tax and a promising economic recovery ended in recession. In August 2000 and again in July 2006, the Bank of Japan raised interest rates, only to cut them again as the economy slid into recession. Undeterred, prime minister Shinzo Abe raised consumption tax in April 2014. The result: another recession.
There is something of a pattern here. Yet Japan is once again flirting with making the same mistake.
Mr Abe came to office in 2012 on a pledge to revive the economy and end the deflation that has plagued Japan since its bubble burst back in 1990. He appointed governor Haruhiko Kuroda to the Bank of Japan and together the two men launched the stimulus known as Abenomics.
The BoJ has purchased assets equal to 100 per cent of Japanese output, delivering a weaker yen, five years of strong economic growth and a drop in the unemployment rate to 2.3 per cent.
Now there are signs of stimulus fatigue. Mr Abe has a maximum of three years left in office. Before leaving, he is eager to declare victory for Abenomics and defeat for deflation. The prime minister insists he will go ahead with another rise in consumption tax next autumn, albeit offset with some dubious stimulus schemes.
Meanwhile, Mr Kuroda says Japan is “no longer in a situation where decisively implementing a large-scale policy to overcome deflation was judged as the most appropriate policy conduct”. To an extent little recognised outside the country, the BoJ is muddying its commitment to easy monetary policy, and edging away from further stimulus.
This stance would make sense if deflation truly were defeated. But it is not. Japan’s economy is doing much better, but underlying inflation, up by 0.4 per cent on a year ago, is still far below the BoJ’s 2 per cent objective.
At some point the long global expansion will end. If Japan has truly escaped deflation, it will endure the resulting shock without a fall in prices. Few would bet on that outcome today.
The clearest sign of waning commitment to Abenomics came with the BoJ’s move this summer to raise its effective cap on 10-year bond yields from about 0.1 per cent to about 0.2 per cent. The BoJ said this was necessary to “enhance the sustainability” of what will otherwise be a policy of continued easing. Nonetheless, it amounted to a tightening of financial conditions at a time when the central bank is still far from its inflation goal.
That decision adds to a tangled mess of promises. The BoJ continues to state it is buying government bonds at an annual pace of ¥80tn, even though it has tapered the actual pace of buying down to about ¥45tn.
It has an “inflation-overshooting commitment”, which sounds tough, but will actually allow it to raise interest rates well before inflation hits 2 per cent. Then there is its new vow to keep interest rates on hold for “an extended period of time” (in the English version of the statement) or “for the time being” (in the Japanese).
Mr Kuroda says the BoJ’s intended meaning is closer to the English phrase. Nonetheless, the overall impression is of a deeply conflicted central bank that no longer seems certain what it is trying to achieve. So far, the BoJ has been lucky: rising interest rates in the US have helped to keep the yen under control. It cannot count on this luck continuing, especially if it were tempted to raise the yield curve cap again.
Such contortions from the BoJ would be easier to accept if there was more evidence of negative side-effects from its huge bond purchases, but the central bank’s own financial stability report finds “no signs of overheating”. It is certainly true that Japan’s banks struggle to make money with such a low level of interest rates. That, however, is because Japan has far too many banks. It is not the central bank’s task to make them profitable.
The temptation to step off the accelerator is understandable. Why, after all, is it necessary to reach 2 per cent inflation when profits are high and unemployment is low? Is the current situation not rather desirable?
But that is like saying you feel better so forget about the rest of the antibiotics. Halting stimulus halfway caused all the previous failures and it will never be possible to control Japan’s public debt unless investment and consumption are strong enough to replace government spending.
That is the whole point of Abenomics.
The right path forward is clear. The Bank of Japan should stop mucking about and clearly state its intention to maintain stimulus until inflation is above 2 per cent. The prime minister should cancel his tax increase until the same goal is achieved.
Together, Mr Abe and Mr Kuroda have achieved great things. They have a duty to continue.
This may be Japan’s last chance to escape the debilitating effects of economic stagnation and falling prices — it is hard to imagine anybody finding the political will to try again.
To give up now, or claim a false victory for political convenience, would be a tragic mistake.
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