If the BOJ really wanted to . . .

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.



28 Responses to “If the BOJ really wanted to . . .”

  1. Gravatar of Benjamin Cole Benjamin Cole
    20. February 2012 at 11:25

    What the BoJ has done to Japan is stupefying.

    Real wages are down 15 percent since 1992 in Japan, industrial output is down 20 percent, property markets are down 80 percent, and the stock market is down 75 percent.

    Sustained tight money is an epic failure. Forgot theories–it just doesn’t work.

    Faith often transcends reason. The tight money crowd–the Theo-Monetarists, the Econo-Shamans–have faith that zero inflation or minor deflation (if such can even be measured) will bring higher living standards. Based on huge empirical results, they are wrong.

    From 1992 to 2008 the USA had inflation in the 2 percent to 6 percent range, and our industrial output doubled, while real income rose nicely. A sharp contrast to the mildly deflationary, perma-recessionary Japan.

    But for the monetarist right-wing, faith trumps reason.

    As it does for left wing, who have faith in fiscal deficits (although belatedly Krugman admits that monetary policy has to accommodate fiscal deficits).

    Onwards, Market Monetarists!!!

  2. Gravatar of K K
    20. February 2012 at 11:32

    They’re just afraid of failure. Like an athlete in a slump, they stop trying since failure is much more palatable if it’s a failure to try in the first place. So are they still the same old omnipotent BOJ from back in the days when the nominal natural rate was positive? Well who knows. And this way nobody will have to find out. Fed’s got the same psychological disorder. (The ECB, on the other hand, is just sadistic.)

  3. Gravatar of Steve Steve
    20. February 2012 at 11:51

    I was surprised you didn’t title your prior post “BOJ raises inflation target from 0% to 1%”

    The fact that they can declare a 1% inflation target and call it easing (with the Yen tanking) tells you everything you need to know.

  4. Gravatar of dtoh dtoh
    20. February 2012 at 12:16

    Three comments.

    1) There is much to be said (especially in Japan) for the argument that it’s better to fail by doing nothing than it is to fail by trying something new.

    2) Much of government policy aims to maintain the corporate/political/government bureaucracies. If real interest rates are viewed as the spread between nominal interest rates and nominal GDP, then it’s clear that the current policies in Japan have produced high real interest rates which retard new business formation and help maintain the power and position of the bureaucrats by blocking the entrance of new economic/political actors. I’m not sure the calculus of the BoJ is that sophisticated, but within the BOJ/bureaucracies there is a strong element of “Deflation/decline hasn’t hurt us so why change anything.” Think North Korea and Burma mindsets.

    I’d be willing to wager a lot that the motivation for the recent inflation target announcement was to weaken the yen to help big exporters and had nothing to do with boosting real or nominal GDP.

  5. Gravatar of Morgan Warstler Morgan Warstler
    20. February 2012 at 12:40

    Why all the hypothesizing?

    Why not ask BOJ?

  6. Gravatar of Rien Huizer Rien Huizer
    20. February 2012 at 12:59


    Maybe the Japanese could create inflation. Maybe not. However it appears that they lack a consensus among people who count (not necessarily ordinary voters) that demands a change. So what? Why not leave that choice (if there is one) to the japanese. Or do they need parenting?

  7. Gravatar of Rien Huizer Rien Huizer
    20. February 2012 at 13:02


    FX policy? Isn’t that what the Koreans do? Much to sneaky for the BoJ

  8. Gravatar of Benjamin Cole Benjamin Cole
    20. February 2012 at 13:28

    Rien Huizer-

    No, the Japanese do not need a parent. But they are an object lesson in what not to do.

    Add on: Yes, they can crimp their economy if they want to. But they do hurt the world–a bigger GDP helps everybody.

  9. Gravatar of Tom Hannaford Tom Hannaford
    20. February 2012 at 13:43

    These are questions for everyone if anyone is inclined to answer:

    1) Has anyone ever seen the Yen this strong compared to the USD? I was stationed in Japan for a number of years up until 2009 and the lowest I can ever remember it getting was about 95 to the dollar (this was about August 2009).

    and 2) To what extent would any of you guys blame the structure of the Japanese economy (well, more importantly their bureaucracy) for their perpetual stagnation? I don’t mean this in a captain obvious sort of way (seems like most people blame the BOJ or the bureaucracy for the problems, just for different reasons depending on who you ask), but more in a “Are we witnessing the lingering effects of Japan’s industrial policy (correct me if my lingo is wrong, I’m just a PR person with limited economics education)”, or is this really an issue that could be remedied relatively quickly with the proper prescription?

    I appreciate any and all answers, as well as any jokes at my expense if the questions seem too vague or redundant. I’m a noob to the MM blogosphere, but my Classical Liberal leanings have me extremely intrigued by the potential of it!

    FTR My prescription in these cases is always the same…more cowbell

  10. Gravatar of Rien Huizer Rien Huizer
    20. February 2012 at 15:13

    Benjamin Cole

    Of course what the Japanese do has international implications. But they are a souvereign state (of sorts) and whatever their democratic processes and institutions produce is legitimate (not necessarily pretty). And if they would “help” instead of “hurt’ (I consider that a very simplistic idea), maybe some free rider would take advantage of that. And “the world” is anarchic enough to leave those practices unpunished.

    Apart from that, Japan’s trade figures appear to show a weakening trade performance. Bad for their GDP but good for trade imbalances?

  11. Gravatar of Benjamin Cole Benjamin Cole
    20. February 2012 at 16:29


    Yes, Japan is running trade deficits. They have huge national debts. They have done everything wrong for 20 years.

    Only a very strong society of sacrifice, cultural socialization and stability is keeping them together. The BoJ is suffocating the economy, on a perverted mission to beat inflation.

  12. Gravatar of JimP JimP
    20. February 2012 at 16:57

    In Spain there is just not enough money around:


    Its amazing. The ECB starves Europe for money and then wonders why Europe is starving.

  13. Gravatar of StatsGuy StatsGuy
    20. February 2012 at 17:57

    I’m not sure I understand your argument – you note that the BoJ was given extreme independence to pursue the policies it wanted, but you don’t explain why the BoJ wanted near zero inflation? I do agree that making the BoJ subject to political pressure would bend monetary policy somewhat, but why should it need to?

    Let me ask the question directly – what interests do the BoJ have in the trajectory that they are only now being forced to alter?

  14. Gravatar of ssumner ssumner
    20. February 2012 at 18:04

    Ben, And the BOJ acts like an innocent bystander!

    K, Good analogies, although in fairness your ECB comments apply better the the Trichet ECB.

    Steve, The reason is because previously there really wasn’t an explicit target, although 0% seemed to be the de facto target. But the language change was not simply raising the target, but also becoming more specific. The BOJ sometimes used to say “stable prices” and sometimes “zero percent or slightly higher” (which could be 1%.) My hunch is that inflation expectations rose (the yen fell a bit) but not 1% higher than before.

    dtoh, I think those are good observations, but I think you understate the split between the government and the ECB. I think the government is more worried about exports and jobs than the ECB (which may favor finance and savers.)

    Morgan, Because they won’t tell the truth, like any other government institution. The BOJ once said more monetary stimulus would:

    1. Do nothing.
    2. Risk hyperinflation.

    Are both true?

    Rien, You said;

    “So what? Why not leave that choice (if there is one) to the japanese. Or do they need parenting?”

    That’s what I’m trying to do. The elected Japanese government wants inflation. The unelected BOJ doesn’t. I assume the elected Japanese government better represents what “the Japanese” want.

    Tom, I think your comments are very reasonable, especially if combined with the previous commenters on Korea. The two countries share some similarities in culture and industrial structure. The difference is Korea is more robust in terms of growth, and Korea doesn’t let it’s currency get so strong. I’m certainly not claiming Japan doesn’t have other problems, other rigidities, but surely part of their recent exports woes have to do with the yen.

    JimP, Thank for the link.

  15. Gravatar of ssumner ssumner
    20. February 2012 at 18:08

    Statsguy, I honestly don’t know. But as you know from my comments about the US, I get extremely frustrated when I read about countries doing lots of fiscal stimulus, running up huge debts, because their central bank won’t do monetary stimulus. Some people say the Japanese like low inflation. Fine, but then why the big deficits?

    I don’t have an answer, I just know that somethings wrong.

  16. Gravatar of Josiah Neeley Josiah Neeley
    20. February 2012 at 18:43


    I quoted you in my Daily Caller column again (on how oil screws up monetary policy):


    I tried to take a Sumnerian line in the column; any errors are, of course, my own.

  17. Gravatar of StatsGuy StatsGuy
    20. February 2012 at 20:22

    … Well, I don’t get it either. I honestly don’t – the biggest culprit I know is the bond market and/or pension systems. It’s tempting to blame the “zombie” banks, but those banks would need to be incredibly short sighted to focus on credit losses instead of asset value appreciation.

    On the flip side, we have:


    What I find extraordinary is this – in the 70s/80s the macro folks were tearing their hair out about democratic impulses toward irresponsible monetary policy (e.g. Dornbusch and LatAm). And yet, it’s precisely the places where democracy has forced the hand of the CBs that are recovering faster. The more insulated the CB from political pressure the worse the economy has done.

    Here’s a thought for you: Rate the CBs across the world in terms of which ones you thought did best vs. worst… I have my rating, probably similar. I’m guessing it’s an interesting list.

    BTW, watch oil closely right now – Greece proves a lovely distraction, but Iran is the real issue.

  18. Gravatar of Steve Steve
    20. February 2012 at 21:40

    “Rate the CBs across the world” best to worst


  19. Gravatar of Mike Sax Mike Sax
    20. February 2012 at 22:48

    “almost all central banks chose 2% inflation and the BOJ chose 1%. These things don’t just happen by accident.”

    Assuming we don’t get NGDP targeting in the near future-an idea that has always sounded good to me, our argument has been over the fiscal side which as there won’t be any for this year(the only possible chance for it would be if the Democrats have a better year than anyone can dream of right now) so really there’s not much reason to argue so much over a counterfactual anyway-a higher inflation target would be an improvement I think. The idea of inflaton targeting would be an improvement too for sure as it would take considerably higher inlfation just to get us back to 2% inflation since 2008.

    Still even so, the 2% inflation target I think can be argued to be too low. Why? Well as Benjamin Cole put it,

    “From 1992 to 2008 the USA had inflation in the 2 percent to 6 percent range, and our industrial output doubled, while real income rose nicely. A sharp contrast to the mildly deflationary, perma-recessionary Japan”

    As the US averaged over the long run even during the Great Moderation inflation considerably higher than 2% a year isn’t this target too low? At least it demands over the long run a tighter monetary policy even than during the Great Moderation.

  20. Gravatar of Jim Glass Jim Glass
    20. February 2012 at 23:38

    Rate the CBs across the world” best to worst

    Rate the most influential central bankers in the USA. Via Macroadvisors

    The winners of this year’s “Who Moved Markets” awards are…

    * The “I Moved Markets Award” goes to St. Louis Fed President Bullard, who had a larger market impact than any other FOMC member. His speeches and interviews moved the two-year Treasury yield by almost 17 basis points last year.

    * The “Power Player of the Year Award” goes to Philadelphia Fed President Plosser, for having the largest impact per speech…

  21. Gravatar of Steve Steve
    21. February 2012 at 01:27

    The recession is driving people crazy: Huge surge in mental illness disability claims.


  22. Gravatar of Henry Bee Henry Bee
    21. February 2012 at 03:50

    Scott, a 1% target is significant when we account for each country’s “natural rate” of inflation as implied by its change in labour force. Due to its rapidly shrinking labour force, Japan has a long-run DEFLATION between 0% and -2%. That’s what the market expects. Therefore, setting a 1% target in Japan may effectively have the same impact on expectations as a 3% target in the US or UK.

    Take a look at figure 1 on Ivan’s blog showing the link between changes in labour force and inflation. I believe adding the concept of “NAIRU for inflation” would improve market monetarism further.


  23. Gravatar of W. Peden W. Peden
    21. February 2012 at 05:12

    Mike Sax,

    It might be a matter of what price index one uses. I imagine that the American CPI GR was in the 2 to 6 percent range; however, that index arguably considerably overstates actual inflation. Apparentely inflation averaged about 2.5% over the 1992-2008 period-


    Monthly CPI inflation ranged from 1.07% to 5.6% –


  24. Gravatar of Mike Sax Mike Sax
    21. February 2012 at 05:40

    Well W. Peden I think at leat the target should be based historically on that period. If you use that lower 2.55 estimate fine-it’s still higher than 2-but then the same measure that got that number should be used by the Fed to make sure it’s apples to apples.

  25. Gravatar of StatsGuy StatsGuy
    21. February 2012 at 06:44

    @Jim G

    Interesting how the top / most vocal slots almost all go to the hawks…

  26. Gravatar of StatsGuy StatsGuy
    21. February 2012 at 06:46

    @Jim G

    Interesting how the top / most vocal slots almost all go to the hawks…

    @ Steve

    What about the smaller CBs? Swiss, Norway, Iceland, etc? Also, developing countries – Russia, Brazil, etc.?

  27. Gravatar of StatsGuy StatsGuy
    21. February 2012 at 06:50

    … nm, Brazil there…

  28. Gravatar of ssumner ssumner
    21. February 2012 at 18:01

    Josiah, Good post. I agree.

    Statsguy, I’d rate those central banks that presided over stable NGDP growth most highly.

    I also agree that oil could be a problem, and that central bank independence didn’t work out too well.

    Mike Sax, I agree that it’s stupid to have lower inflation during a period of high unemployment than during the Great Moderation.

    Jim Glass, I’m guessing Plosser had a negative impact on markets. 🙂

    Steve, Yes, disability claims rise when there are no jobs.

    Henry, Actually there is no such thing as a natural rate of inflation, Japan could have 60% annual inflation if it wanted.

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