Academics, central bankers and politicians are divided over the issue currently occupying the center stage of public debate: a monetary policy tool known as inflation-targeting.

Is inflation-targeting desirable? Is it effective? And is it even feasible?

The following is a review of basic facts swirling around the debate:

What exactly is inflation targeting?

It entails an announcement by the central bank, in this case the Bank of Japan, that it will keep the pace of price increases, or the inflation rate, at a certain level — 2 percent to 3 percent, for instance — over a specific period of time.

What is all the fuss about things getting cheaper anyway? Isn’t that good for consumers?

Sure, but that depends on how long prices keep falling. Continually declining prices will eventually take a bite out of most companies’ sales revenues, which then leads to cuts in employees’ wages, who in turn spend less. Falling demand then forces prices still lower, and the cycle continues.

Ultimately, companies fail and unemployment rises, with serious consequences, especially for a nation with few new industries emerging to help drive the economy forward.

In Japan, consumer prices have fallen at a rate near 1 percent from the previous year for three straight years, with no sign of them rising soon.

Politicians are making statements on inflation-targeting almost every day. Why is there such an intense focus on the issue now?

Part of the reason is that Prime Minister Junichiro Koizumi is preparing to choose a successor to Bank of Japan Gov. Masaru Hayami, whose term expires March 19. Since the BOJ governor by law acts autonomously, choosing a like-minded governor is the Cabinet’s best chance to influence monetary policy.

Another reason is that it is not just overall prices that are falling. Wages, in particular, are being bludgeoned. Politicians are equating deflation with voter-dissatisfaction. Also, prices on land accepted as loan collateral have plunged, which means trouble for banks that are being pressed to clean up problem loans, along with their clients.

How could the BOJ achieve an inflation target?

Proponents say the BOJ should not just buy up government bonds, but also land, stocks and foreign government bonds, in order to boost prices.

If the BOJ is committed to an inflation target, it raises expectations that prices will move in line with central bank pledges. Higher expectations for inflation will, in theory, encourage consumers to spend rather than save.

Some proponents suggest introducing penalties for the BOJ governor if the bank fails to meet its target. In New Zealand, for example, the government can dismiss the central bank governor if prices fluctuate outside a target range.

What does the BOJ say about the effectiveness of inflation-targeting?

Hayami says textbook economics doesn’t apply. The assumption behind an inflation target is that price levels are directly related to the amount of funds the central bank puts in circulation and in reserves.

The BOJ has already voiced its commitment to stopping the decline in prices and has flooded banks with extra funds.

Short-term interest rates are already at zero. The monthly total amount of money in circulation and reserves has surged, up to 36.3 percent on a year-on-year basis in 2002.

With banks too weak to take marked risks and companies too indebted to take out new loans, however, this has had little effect.

What do proponents say to that?

They say that credit demand does exist — but that healthy companies are not willing to take out loans because they believe prices of goods and services will continue to fall.

What are the potential risks of inflation-targeting?

Keeping a rein on price controls is tricky business, since there is a large time lag between monetary policy and its effect on prices. Opponents are concerned over whether the BOJ’s excessive credit-easing policies today will one day trigger hyperinflation that will be difficult to curb.

Another risk, according to the BOJ, is that if the value of land or stocks bought by the BOJ falls, this could deplete funds that the BOJ supplies the national treasury. Ultimately, there is a risk that taxpayers will have to pay the difference.

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