Manipulation of a key index

A joint statement issued by the government and the Bank of Japan on Tuesday stated that the central bank will adopt a 2 percent inflation target, discarding its rather loose 1 percent price-stability goal that it adopted last February. The BOJ will also start buying about ¥13 trillion in financial assets, including some ¥2 trillion in government bonds, every month as long as necessary starting in January 2014.

This represents a drastic change in the BOJ’s approach. The BOJ has been reluctant to adopt such an inflation target in view of Japan’s economic condition over the past two decades. It also means that it has bowed to some extent to government pressure.

In the campaign for the Dec. 16 Lower House election, the Liberal Democratic Party had called for the adoption of a 2 percent inflation target, and Prime Minister Shinzo Abe has called for unlimited monetary easing to pull the Japanese economy out of its long-term state of deflation.

Now that the BOJ has adopted a new direction, the big issue is whether it will have desirable effects on the real economy. Tuesday’s joint statement may help market numbers in the short term. But whether the BOJ’s new policy will bring about actual improvement in the employment situation and wage increases remains to be seen.

If past experience is any indication, achieving 2 percent inflation won’t be easy. Even during the Japanese bubble economy of the late 1980s, average annual inflation was only 1.3 percent. Since then, the BOJ has refused to set an inflation target that deviates greatly from economic reality.

If the government and the central bank are obsessed only with realizing 2 percent inflation, a situation may develop in which prices rise while people’s disposable income remains stagnant. This would only exacerbate economic conditions. It’s possible that an economic bubble could form under the BOJ’s new policy.

The policy accord between the government and the BOJ also carries the danger of giving rise to a perception that the BOJ’s independence has been compromised by the government. If this happens, public trust in Japan’s state finances will weaken, leading to a collapse of government bond prices and a rise in long-term interest rates. Another worrisome factor is that the government’s economic policy thus far shows that it does not pay much heed to financial discipline even though government debt has grown to about twice the nation’s gross domestic product.

The BOJ’s new policy will also cause the yen to weaken. So, utmost care must be taken to prevent central banks of major economies from competing to devalue their own currencies.

Monetary policy alone cannot cure Japan’s economic disease. The government must also promote activity in promising economic fields and strengthen Japan’s R&D capabilities to boost the economy and improve the employment situation. It should also keep in mind that unless the nation’s social welfare system is strengthened, people will not loosen their purse strings.