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Monday, February 24, 2003

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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