Inflation goal kills BOJ flexibility

In its half-yearly Outlook for Economic Activity and Prices report on April 26, the Bank of Japan predicted that fiscal 2015 will achieve a 1.9 percent rise in the consumer price index, following a 0.7 percent rise in fiscal 2013 and a 1.4 percent rise in fiscal 2014, showing the BOJ’s view that its goal of achieving a 2 percent inflation is within reach.

But the BOJ should not stubbornly stick to the 2 percent inflation goal. It will be deprived of flexibility in its monetary policy. It could also cause undesirable side effects. A May 3 summary report on the April 3 and 4 discussions by the nine BOJ Policy Board members shows that some board members feared negative effects of massive monetary easing on banks, life insurance companies and the function of the market itself.

Compared with past experience, the BOJ’s goal under its new governor, Haruhiko Kuroda, appears unrealistic. Even when the Japanese economy was in a “bubble” from the late 1980s to the early 1990s, the average annual inflation rate was only 1.3 percent. As of January, when the BOJ was headed by then Gov. Masaaki Shirakawa, it predicted that the consumer price index would rise 0.4 percent in fiscal 2013 and 0.9 percent in fiscal 2014.

In March, the price index fell 0.5 percent. Many private sector economists are skeptical about the BOJ’s 2 percent inflation goal. In fact, in writing the latest Outlook for Economic Activity and Prices, two BOJ Policy Board members opposed the expression that a 2 percent price rise will be realized in the latter half of the period covered by the report, which is fiscal 2013, 14 and 15.

The BOJ plans to double the amount of funds supplied to the market in two years to raise the price index by 2 percent. Mr. Kuroda hopes that this policy creates the expectation that prices will go up among people and business enterprises, leading them to buy more goods and services and carry out more capital investment, thus stimulating the economy. But there is no guarantee that this scenario will happen.

A situation may arise in which the monetary easing will cause bubbles in the stock market and the real estate market while the overall price level will not rise so much. If the BOJ pursues further monetary easing to achieve its 2 percent inflation, this could cause formation of devastating economic bubbles.

Price rises of imported raw materials and fuel caused by a cheap yen will not only worsen business enterprises’ profitability but also make consumers’ lives difficult. The BOJ’s massive buying of government bonds from financial institutions could also lower trust in Japan’s financial discipline and trigger higher long-term interest rates, increasing the government’s financial burden. The BOJ should have the courage to change its policy if the nation’s economic conditions make it necessary.