Debate on how Japan can pull itself out of its worst postwar economic slump has entered a new stage.
Calls are rising — from within the ruling Liberal Democratic Party and from prominent economists at home and abroad — for the Bank of Japan to underwrite government bonds to stop the surge in interest rates. The BOJ and the Finance Ministry both oppose the idea, arguing that it would worsen the economy.
Here are some questions and answers regarding this complex issue.
1) What’s going on with government bonds?
The government, which already has acquired a massive borrowing habit, will issue 31 trillion yen in new bonds to finance a series of economic stimulus measures in the general account budget for fiscal 1999, which starts April 1. That amount is nearly double the amount in the initial plan for fiscal 1998.
This worsens the supply-and-demand balance in the secondary bond market. It is believed that the rise in supply causes bond prices to fall; think of the price of an apple after a bumper harvest. The lower price of bonds later translates into higher yields for investors.
The yield on the key 10-year Japanese government bond topped 2.3 percent in Tokyo earlier this week, a 1 1/2-year high. The yield was below 1 percent in the fall.
2) What does that have to do with interest rates?
A high yield on the benchmark government bond helps push up other long-term interest rates, including those on loans from banks to firms and home buyers. Higher long-term interests discourage business investments and home purchases, which doesn’t bode well for an economic recovery.
3) Why do some people think the BOJ should buy government bonds?
Proponents argue that the nation’s central bank should buy the bonds directly from the government, not in the market, to cut down the supply and keep prices from falling and interest rates from climbing. There is no other means available for the BOJ or the government to salvage the economy, they claim.
It is widely considered that further lowering the official discount rate — the rate the BOJ charges commercial banks — from a historic low of 0.5 percent would be ineffective.
4) Why are the BOJ and the Finance Ministry opposed to the idea?
They fear the scheme would rob them of a natural restraint of fiscal policy. They say it could allow the government to end up borrowing an unlimited amount of money — easy money — from the central bank. This could cause “rampant inflation,” as BOJ Gov. Masaru Hayami has said, by distributing a huge amount of money around the country.
Hayami also has said Japan would lose market confidence and private credit rating agencies would downgrade Japanese government bonds. This, they fear, would bring about the opposite of what was desired: a further rise in long-term interest rates.
The Finance Ministry has been cautious about issuing bonds, but Finance Minister Kiichi Miyazawa seems to have a slightly different stance from Hayami’s. He said Friday that the operation is “not necessary” but that having discussions on the issue wouldn’t be bad.
5) Is it prohibited by law?
Yes. The BOJ’s buying of new government bonds is banned under fiscal law, following lessons learned from skyrocketing inflation soon after World War II. Such an operation is similarly prohibited in other major industrialized countries, including the United States.
However, the fiscal law exceptionally allows the operation when “there is a special reason” and “within the amount approved by the Diet.”
6) Can the BOJ not buy government bonds any other way?
Actually, as a legal tool of monetary policy, the BOJ does buy already-issued government bonds in the market to adjust the amount of funds. Some economists have suggested that the bank should buy more of such bonds in this way to produce the same effect as buying new government bonds.
But the BOJ hates this idea as well, because the bank believes such an operation would ultimately result in the infinite issuance of government bonds.
For the same reason, the BOJ also opposes the idea of temporary legislation that specifies the upper limit for the bank to buy new government bonds.
7) If the BOJ is not to buy new bonds, what should be done to shore up the economy?
Apparently, there is no quick solution. Solving the banking sector problem, further market deregulation and public works spending on more efficient areas are necessary all the same, some economists say.