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Inflation targeting easy to promote, but difficult to achieve without tools

by Teruhiko Mano

Special To The Japan Times

T he government of Prime Minister Shinzo Abe and the Bank of Japan agreed last week to set a 2 percent inflation target to be achieved “as soon as possible.” All sorts of issues have been raised, from the dangers of intervening in monetary policy to the waning independence of the central bank, but there are many problems inherent with inflation targeting.

The first problem is that the joint accord merely clarified their target — 2 percent inflation — without specifying the tools to be used to achieve it.

“Abenomics” is aggressive on monetary policy, flexible on fiscal policy and attempts to encourage private-sector investment. The BOJ will likely come under greater pressure than ever to expand quantitative easing. But the results of its ultraeasy monetary policy have been quite limited over the past two decades, and we cannot expect monetary policy alone to drive economic growth in any substantial way. Abe’s administration is well-aware of that, which is why his Cabinet adopted a ¥20 trillion stimulus package on Jan. 11. That, of course, entails the problem of expanding the fiscal debt.

The second problem relates to the fact that the inflation-targeting policy doesn’t specify the logic behind the inflation target. At a time when Japan’s potential growth rate is believed to have slipped into the 1 percent range because of population decline, the government has not clearly explained why it expects nominal growth to exceed 3 percent (1 percent real growth plus 2 percent inflation).

True, share prices went up and the yen fell against the dollar after Abe’s Liberal Democratic Party won the December general election. But this merely reflected the markets’ widespread discontent with the Democratic Party of Japan’s team, which failed to live up to expectations. Whether these positive trends will last depends on what happens from here on out.

The third problem is that the policy only states that 2 percent inflation is to be achieved “as soon as possible.”

The word “soon” made trouble frequently last year when everyone was waiting for then-Prime Minister Yoshihiko Noda to dissolve the Lower House. But while the Lower House can be dissolved at anytime the prime minister chooses, 2 percent inflation is unlikely to be achieved so easily given today’s globalized economic environment. Setting an unrealistic deadline can hardly be called responsible policymaking.

Abe is apparently pursuing massive fiscal measures as well, but we have to realize that the biggest reason Japan experienced two “lost decades” was that it lacked stable governments with fiscal discipline.

Since the LDP’s first fall from power in 1993, Japan has gone through 14 prime ministers, including Abe from 2006 to 2007. Each lasted about 1½ years on average, with the DPJ going through three of them during its three years and three months in power.

In these two decades, Japan’s public-sector debt ballooned to double its gross domestic product under a succession of populist teams that paid less attention to fiscal discipline than spending. The divided Diet can be brought to an end if the LDP wins the Upper House election this summer. If that happens, I would urge the Abe government not to make hasty moves, but to take steady steps to formulate and implement solid policy actions.

Finally, the biggest problem is that achieving an inflation target will not necessarily improve people’s lives or increase tax revenues.

As globalization continues, rising prices at home will not automatically translate into higher domestic economic growth, more jobs or higher wages. As has been pointed out by some in the LDP, a weaker yen raises the cost of buying imported fuel and other raw materials.

It is estimated that every time the yen’s value drops ¥1 against the dollar, Japan’s annual energy costs rise by ¥270 billion, eating into corporate earnings, household spending and increasing the risk of trade wars.

The government’s role is to maintain and stabilize people’s lives. An inflation targeting strategy must entail an increase in wages and pension benefits to match the rising prices. If the government is imposing a 2 percent inflation target on the Bank of Japan, it also must promise to raise wages and pension benefits by at least 2 percent.

We have to realize that inflation targeting looks easy on paper but entails a multitude of problems in economic reality.

Teruhiko Mano is an international economics analyst.