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Friday, February 28, 2003

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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