A year into the deflation fight

Ayear after taking the helm of the Bank of Japan, Haruhiko Kuroda appears to be on course to achieve the targets he set in the quest to end Japan’s protracted deflation and put the economy on a growth path.

Consumer prices — which were still falling when he became BOJ governor in March last year — marked a 1.3 percent year-on-year rise in January, and Kuroda says he is confident the prices are on track toward his goal of 2 percent inflation within two years, excluding the effects of the consumption tax hike in April.

Market sentiments changed a year ago when the new BOJ governor, picked by Prime Minister Shinzo Abe, introduced aggressive monetary easing measures, pledging to double the nation’s monetary base — the amount of money the central bank supplies in its money market operations — in two years, mainly through the massive purchases of government bonds.

The yen fell against the dollar, and the upsurge in the stock market gained speed. Export-oriented large manufacturers reported sharp gains in earnings aided by the weak yen, while luxury goods sales and the real estate market picked up.

However, price increases at this point seem to be more a reflection of increased costs of imports due to the yen’s decline, rather than rising demand based on higher consumer spending and wage increases. The sharpest pay raises in years offered by leading firms that benefited from the weak yen have not yet been widely shared by small and medium-sized firms, which hire 70 percent of the nation’s employed workers.

The consumption tax hike next month will put an additional burden on households whose income has not increased as fast as price increases. The BOJ’s 2 percent inflation target could be in doubt if the expected slump in consumer spending after the tax hike bumps the economy off the recovery path.

Kuroda uses the outstanding amount of the monetary base, instead of interest rates, as a yardstick in managing monetary policy. His goal of boosting the monetary base from ¥138 trillion at the end of 2012 to ¥270 trillion by the end of this year was a bold move. Under Kuroda’s predecessors, the central bank had taken 13 years to double the monetary base. The amount reached ¥204 trillion at the end of February, up 56 percent from a year ago.

But much of the massive funds newly supplied by the BOJ stay in checking accounts that financial institutions hold in the central bank after the bond purchases; the funds are not reaching businesses and individuals.

The total amount of money kept in such accounts is reported to have hit ¥110 trillion as of the end of January, up sharply from ¥47 trillion a year earlier.

Meanwhile, bank lending has not expanded as much — apparently because of continued slow growth in demand for funds by businesses and individuals. The year-on-year increase in outstanding bank lending stood at 2.4 percent in February, compared with 1.5 percent in March 2013.

In a bid to stimulate the business appetite for funds, the BOJ last month extended by another year a low-interest loan program to those financial institutions that increase lending to growth sectors, and doubled its scope. The central bank says such steps will help spread the effects of monetary easing through the economy.

The uptrend in prices could signal a turnaround, and the supply of money has rapidly expanded. But an end to deflation on a sustained basis will require more robust demand by businesses and consumers on the basis of higher earnings and income. The mission of conquering deflation is only halfway done.

  • http://www.sheldonthinks.com/ Andrew Sheldon

    If one wanted to study the relationship between monetary policy and inflation as a point of correlation, I think Abe has just provided the perfect case study, because he has done little else. This is not to disparage him because I think he intends to get around to it, if anyone gives him a chance. In his attempt to be all things to all men, he is seemingly doing a great job at inciting their antagonism.