There have been two views of the Great Japanese Deflation. The standard view is that the Bank of Japan repeatedly tried all sorts of monetary stimulus, but nothing worked. My view (and that of many other market monetarists) is that the Bank of Japan acted as if it didn’t want inflation, tightening policy in 2000 and 2006, despite no inflation. In my view the press and many economists were somewhat naive in accepting the BOJ’s claim that there was little they could do to end deflation. After all, the yen is a floating fiat currency.
Here’s the Financial Times expressing surprise at the BOJ’s new inflation target of 1%:
What’s less obvious, however, is why the BoJ’s policy board has opted for such a low target.
Inflation targeting is supposed to work by influencing expectations. Targeting inflation of 1 per cent will, therefore, do little to convince markets and the public that the central bank is hell-bent on boosting growth.
If the BoJ really wanted to signal its intent to fight deflation, then it would make a lot more sense for the Policy Board to begin by targeting inflation of above 2 per cent, before lowering it on signs that demand was recovering.
Yes, IF they really wanted inflation. But they don’t. There’s a reason why almost all central banks chose 2% inflation and the BOJ chose 1%. These things don’t just happen by accident.
I used to wonder why the BOJ tightened so much in late 2006, raising interest rates and reducing the monetary base by 20%. Another Financial Times story gives us the answer:
In recent years, the bank has tended to shrug off overt political pressure. A 1998 revision of the BoJ law strengthened its operational autonomy by removing the government’s authority to dismiss the governor and deputy chiefs.
Only under prime ministers with very solid popular support, such as Junichiro Koizumi between 2001 and 2006, has the BoJ appeared to bend to the government’s will. It has put up a particularly strong defence of its independence under Mr Shirakawa, promoted from deputy governor in 2008.
The difference now is twofold, say analysts. Firstly politicians are worried about their own job security, thanks to a persistently strong yen and the related “hollowing out” of Japan’s manufacturing sector.
. . .
“The linkage between the exchange rate and deflation is now clearer in [the] minds of politicians,” said Robert Feldman, senior economist at Morgan Stanley MUFG Securities. “As long as we have deflation the yen gets stronger.”
As of 7pm in Tokyo on Thursday, the yen had weakened about 1.5 per cent against the dollar since the BoJ announcement on Tuesday.
The second reason for the unusual degree of political pressure is that Mr Shirakawa’s five-year term expires in April next year. The governor, deputy governors and six members of the nine-member policy board are officially nominated by the cabinet, and approved by the Diet. Internal candidates from promotion will be anxious not to rule themselves out of contention by appearing too hawkish, say analysts.
“Senior BoJ officials are aware that the government could be trying to exclude them [from selection]. That is why they are trying to improve relations,” said Hiromichi Shirakawa (no relation), chief Japan economist at Credit Suisse.
. . .
But while the yen remains strong, and while the governor runs down his time in office, external pressure to ensure the bank’s policies do not jar with the government’s is unlikely to relent. And neither will the anti-deflation lawmakers.