A Spot of the Right Stuff at the BoJ?

Mein Gott, I can't believe it. Richard Katz, a Japan commentator I don't always agree with but who I do respect, has come out and said the unsayable, Toshihiko Fukui is the right man in the right job. (In fairness many pragmatic commentators inside Japan had been coming round to this view, this and the view that the important thing is not just the head man, but the team). The reason Katz thinks this is that he isn't convinced of the monetary policy can do it alone story (lets call this the helicopter money - actually, I even found one Japanese economist imaging this - dropping money from helicopters to provoke inflation - was actually being proposed: still its a nice idea, it would make what is already a lottery into an even bigger one, somehow this puts me in mind of an old Borges story about Babylon......). Katz's reasoning here is faultless as far as I am concerned. With all due defference to heavyweights like Paul Krugman and Ben Bernanke fuelling a 4% inflation rate isn't a problem, it's keeping it there that is the problem, and maintaining the credibility that it's going to stay there, remember yield curves are now flattening out up to the 30 year mark. There's more to the Japan problem than simply its liquidity trap. Until Japan begins to address its structural problems there will be no lasting cure for the deflation.

My principal difference with Katz: in position number one on the structural reform list I put structural reform of the population, ie opening big-and-wide the immigration tap, without this I feel fiscal policy will be less than useless, in particular with the dead weight of the debt looming just round the corner. One other difference between me and Katz: I'm certainly not prepared to stick my neck out for Fukui-san, nor for Takenaka-san, nor for Koizumi-san. The de facto powers who exert such influence on the day-to-day conduct of economic affairs are far too important to be discounted so easily. Still, in the right circumstances Fukui may prove to be more of a runner than was previously expected. Or are we all just clutching at starws here? One curious detail about the saga is the growing mention of one lesser member of the Bush economic team: John Taylor - he of Taylor rule fame - at the international affairs section of the US Treasury.

It is hard to see how Japan's economy can reform and recover unless reformers are put in charge of vital policymaking institutions. That is why the appointment of Toshihiko Fukui as governor of the Bank of Japan is a positive step. His view is straightforward: deflation cannot be stemmed through monetary easing alone, which makes structural reforms more important than ever.


Even some of those who want the bank to inject "unconventional stimulus" acknowledge it cannot revive the economy by itself. Heizo Takenaka, minister for economic policy and financial services, has made it clear that monetary easing will not suffice without the disposal of bad debts. So has John Taylor, undersecretary for international affairs at the US Treasury. Mr Fukui will bring more to the table than the reformist philosophy he shares with Masaru Hayami, his predecessor. Even critics acknowledge his political acumen, flexibility and a dense network of supporters in politics and business. These assets could make him more effective than Mr Hayami in building consensus for action on bad debts supported by monetary easing. The main alternative is the futile hope that massive money-printing, like government spending on "bridges to nowhere" in the past, can substitute for real reform. Critics claim that the BoJ could create 3-4 per cent inflation at will and that this inflation would, in turn, revive private demand. Some advocates of inflation targeting even suggest that the bank buy up assets used as collateral for bank loans, from equities to office buildings. While many economists sincerely believe such measures would help, it is the opponents of reform who are the most fervent advocates. They hope that raising the price of stocks and property can make bad loans good without restructuring "zombie" borrowers - companies that are essentially bankrupt. The more Japan's leaders grasp at monetary straws, the less likely they are to undertake true reform.

Japan's deflation is not the cause of weak demand but a symptom. Prices are falling because the economy is operating at 4-5 per cent below capacity. The bank cannot create steady, manageable inflation just by printing more money. It has tried. It has increased the monetary base by almost 40 per cent since March 2001. Interest rates have responded - the yield on a 10-year government bond is now at a record low of less than 0.8 per cent. But little else has improved. The rest of the broad money supply has barely changed. Meanwhile, bank loans, prices and nominal gross domestic product have all kept falling. Certainly, the Bank of Japan can boost the price of any asset it buys. If it offered to print unlimited money to buy buildings at double their current price, building prices would immediately double. Developers would construct buildings just to sell them at high prices to the bank. However, when it stopped buying, prices would fall back. Such a move would re-create the late-1980s boom and bust on a grander scale.To his credit Mr Hayami blocked such schemes - and so will Mr Fukui. But beyond rejecting false cures, the bank has to stress what it and the government can do. If deflation is a product of weak demand, the solution is to boost demand directly. The surest initial step is a permanent consumer tax cut in the order of a few per cent of GDP financed by the bank. That would put money into people's pockets without raising interest rates.
Source: Financial Times
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Bank of Japan: the Speculation is Over

Well finally the speculation is over, and Japan has got a new governor for its central bank. Much to the sighs of disappointment across the planet, the newcomer is not an inflation targeter, in fact he is a tried and trusted member of the old guard, so in theory this means more of the same. But since nothing is ever completely predictable, and even less so in Japan, we may still see some surprises. Japan is, after all, mired in deflation, with government debt rising every year and no sign of capacity to repay improving. So, one day or another, something has to give somewhere.

Toshihiko Fukui has been named by Junichiro Koizumi, Japan's prime minister, as his choice to be the new governor of the Bank of Japan, prompting critics to question Mr Koizumi's qualifications as a reformer and Japan's commitment to tackle deflation. Mr Fukui, former deputy governor of the BoJ before resigning amid scandal in 1998 and currently head of the Fujitsu Research Institute, a think-tank, is a career central banker expected to continue the policies of the incumbent governor, Masaru Hayami.

Mr Fukui's nomination indicates strongly that future moves by the BoJ to tackle inflation will not make use of so-called unorthodox measures such as an inflation target or the purchase of overseas assets, but will continue the current policy of injecting liquidity into the banking system.Peter Morgan, economist at HSBC Securities, said: "Mr. Fukui's views on monetary policy are conservative, and in line with the mainstream of the Bank of Japan. This means that there will be no break in the BoJ's monetary stance, and that the adoption of unconventional policy measures is extremely unlikely. Adoption of an inflation target is also unlikely."
Source: Financial Times
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Japan Prepares to Say Farewell to Hayami

Central bankers are a select group. Some like Alan Greenspan, Wim Duisenberg, Eddie George become household names. Others seem more comfortable with obscurity (the is not the same thing as obscurantism which is undoubtedly Duisenbergs best known attribute). Masaru Hayami, who will complete this month his five-year term as governor at the Bank of Japan, would probably have preferred the obscurity, but Japans continuing economic plight, and its significance in the world economic order have meant that this preference was not to be respected. In particular this has been the case since during his watch at the bank Japan has been the first major economy in recent times to face a sustained battle with deflation, and as a consequence the eyes of the economic world have scrutinised every decision looking both for a way out, and for lessons for the rest of us.

Hayami took control of Japans monetary policy levers in March 1998, after his predecessor resigned following a wining-and-dining scandal involving top Bank of Japan officials. Much was expected of him, and, in the event, criticism of him has been widespread, first and foremost for the fact that he appears to have had more fear of provoking inflation than he did of permitting deflation to continue. His most notorious failure: the decision to terminate the zero interest rate policy in August 2000, right after the NASDAQ bubble burst, only to have to re-introduce it and change course yet again in March 2001. As the eyes of the world turn towards the appointment of his successor, and to whether or not he will be an 'inflation targeter', the Daily Yomiuri offers us this assessment of Hayami the central banker:

With extensive experience in both the private sector and the central bank, Hayami was expected to usher in a new era for the nation's financial guardian. But instead, Hayami failed to recognize that his key mission was to overcome deflation as he was haunted by the specter of inflation, which had troubled the nation's early postwar years. The year that preceded Hayami's accession to the governorship was plagued with financial woes for the nation, including the collapse of former giants including Yamaichi Securities Co. and Hokkaido Takushoku Bank. Yet despite the prospect of far-reaching economic fallout from such financial woes, the central bank failed to quickly respond to the unprecedented situation. It was not until September that year that the central bank reduced its benchmark short-term interest rate--the unsecured overnight call rate--to 0.25 percent. However, the effects of the rate change were minimal, and the central bank was subsequently forced to adopt a zero-interest rate policy in February 1999. From the perspective of a traditional central bank, such a move was unusual in that it had effectively given up one of its most powerful monetary policy instruments. Thereafter the Bank of Japan went on a policy zigzag, bringing an end to its zero-interest rate policy in August 2000 despite warnings concerning the nation's worsening deflation, especially after the bursting of the information technology bubble in the United States. However, the central bank's decision to hike rates was strongly criticized, and the bank reinstated its zero-interest rate policy just six months later. In March 2001, financial uncertainty again rocked the economy as companies closed their accounts for the fiscal year-end. In a last-ditch effort to overcome a deflationary downturn, the central bank changed its policy from targeting interest rates to quantitative monetary easing--a policy of raising the balance of current account deposits held by private financial institutions at the central bank.

But when the new policy failed to work, Hayami reportedly responded to growing criticism by indicating to then Prime Minister Yoshiro Mori that he wanted to resign. Central bank officials seem to have an inclination to accept a certain level of recession on the grounds that an economic contraction is an inevitable consequence of speeding up the disposal of banks' nonperforming loans and hastening structural reforms. Some top officials have openly stated that recent price falls are "good" as they allow consumers to buy quality goods cheaply. The central bank officials' lack of recognition of the problem has resulted in their failure to implement timely antideflationary measures. This has caused deflationary pressures to accelerate, a situation for which Hayami must accept responsibility. Nevertheless, in contrast to general discussion on the topic, Hayami and his experts at the central bank may not have been as timid or conservative as one might have been led to believe. Not only have their adoption of a zero-interest rate policy and quantitative easing been bold steps, but other measures such as the purchase of stocks held by banks should be applauded for having gone beyond the traditional bounds of central bank policy, such as open-market operations and lending to banks.

Yet as soon as the economy appears to be on the verge of recovery, the central bank has nipped it in the bud by reimposing a tight-money policy, a habit it seems incapable of shaking off. Market players are well aware that the central bank has no option but to continue its easy-money policy as it has been unable to devise policies to overcome deflation. The central bank's reluctance to act has resulted in the yield on the benchmark 10-year government bond falling to a record low of 0.75 percent at the end of January, indicating that the market expects deflation to continue. The central bank's maneuvering of the overnight call rate formerly acted as an alarm bell for the market. The bank would leak its rate decisions if it judged the economy was overheating, using the announcement effect to fine-tune the economy.

This jawboning of the market by the central bank indicated to market players that the Bank of Japan was keeping a close watch on the nation's financial health. But now, the bank is sending out unfavorable signals that may prolong deflation and its ultra-easy monetary policy for no good reason. If a central bank fails to devise policies to influence the market, its raison d'etre must be called into question. What about purchasing a wider range of assets as the next strategy? If the bank purchased exchange-traded funds or real estate investment trusts, it would boost land and stock prices, helping to improve the banks' balance sheets as they hold large amounts of such assets as collateral. May the new governor be reminded for the last time that deflation is the nation's economic enemy, not inflation or an asset bubble. It is hoped the new central bank chief will be both courageous and flexible in carrying out the policies to overcome such a financial foe.
Source: Daily Yomiuri
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The Economist: Giving Up on Japan?

This weeks Economist piece on Japan almost sounds demoralised and despondent. Are they coming near to throwing the towel in. The article's author doesn't even seem to believe the BoJ will be headed by a deflation targeter any more (they are probably right on this: in fact those like me with a warped sense of humour are begining to imagine the whole Nobuyuki Nakahara affair was 'leaked' to the press to derail any possibility of the candidature ever being presented). Sure, the problems sometimes have a now you see me, now you don't feel about them, but they are real enough even if last weeks official GDP figures confounded all expectations - mine and the Economists alike - by showing that the Japanese economy continued to expand in the final quarter of last year. This news, however, will not make deflation disappear, nor will it take the heat off Japan�s government, which according to the Economist now "appears to be incapable of tackling the country�s deep-seated economic problems".

GOOD news about the Japanese economy is rare these days�and surprising. Most economists had braced themselves for the news that the Japanese economy had shrunk in the final quarter of 2002. So the official figures, released on February 14th and showing that the economy expanded in the October-December quarter, caught people off guard. Growth was modest enough: just 2% at an annual rate. But it means that the economy has now grown for four quarters in succession, and that the country�s fragile recovery is not�yet�over. The figures will provide a welcome breather for the Japanese government, but one likely to be shortlived. The economy�s problems remain daunting and the new data followed hard on the heels of a further slide in business optimism. Moreover, they came just a few days after a new opinion poll showed that the popularity of the prime minister, Junichiro Koizumi, had slumped.


Tackling deflation is a matter of urgency. But even those economists for whom inflation targeting is the preferred solution accept that, by itself, ending deflation will not solve Japan�s problems. What is needed is concerted reform on several fronts�monetary, fiscal and structural. Japanese government debt now exceeds 150% of GDP (more than double the upper limit set by the European Union) and is rising fast. What to some observers seems like an endless series of fiscal-stimulus packages has had almost no economic impact, in part because of a misguided emphasis on wasteful, expensive public-sector construction projects. These have benefited the LDP�s corporate contributors more than the wider economy. Co-ordinated reform seems beyond the current political establishment, and commentators have given up talking about Japan�s last chance to change before being engulfed by a full-blown crisis. The slow speed of the economic decline has meant that the debate within Japan has lacked the sense of urgency that would be needed to overcome opposition to reform. But for Mr Koizumi himself, time might be running out. There is talk of his vulnerability in the LDP leadership election due in September and speculation that he might try to head off a challenge by calling an early general election. What that would do to improve Japan�s miserable economic prospects is far from clear.
Source: The Economist
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