Bank of Japan Gov. Haruhiko Kuroda’s role as the prime focus for efforts to revive the world’s third-largest economy is coming to an end.

An unprecedented level of concern about damaging side effects of Japan’s multidecade experiment with ultralow interest rates has gripped policymakers, regulators and legislators. The key takeaway: Fiscal policy is set for a more prominent part during the next economic downturn.

Why the change? A tense meeting in the BOJ’s drab annex building on Sept. 26 helps illustrate the central bank’s predicament. Recognizing the importance of public support for any move to cut the minus 0.1 percent policy rate, officials sought understanding from representatives of the shinkin (regional cooperative banks). But rather than accept that more monetary easing may be needed, one key banker tersely warned such a move would intensify pressures on the lenders and even pressed for a hike, according to people familiar with the exchange.

Koichi Hamada, a member of Prime Minister Shinzo Abe’s original brain-trust of reflationists, says monetary policy was very effective right after 'three arrow' Abenomics program began but that it’s hard to make a significant impact on its own now.  | BLOOMBERG
Koichi Hamada, a member of Prime Minister Shinzo Abe’s original brain-trust of reflationists, says monetary policy was very effective right after ‘three arrow’ Abenomics program began but that it’s hard to make a significant impact on its own now.  | BLOOMBERG

Global shift

The pendulum swing away from monetary measures is part of a global shift seeing calls for increased government spending after a decade of easy money inflated asset prices, elevated debt levels and worsened wealth gaps, but did little to generate sustained wage and price gains. It also marks a turnaround, given that BOJ officials were confident as recently as mid-September that Japan was prepared to accept more deeply negative interest rates.

“When Abenomics started, I wouldn’t have thought about me talking about the importance of fiscal stimulus,” said Koichi Hamada, a member of Prime Minister Shinzo Abe’s original brain trust of reflationists, who had advised on the nomination of Kuroda and other BOJ board members. “Monetary policy was very effective right after Abenomics began, but it’s very hard to make a significant impact on its own now.”

Signs of a shift in thinking were evident in remarks by Kuroda following the last two BOJ policy meetings. Five days after the September gathering, the BOJ chief talked up the power of lower short-term interest rates. But five days after the October one, he hailed the effectiveness of “more aggressive” fiscal policy, supported by ultraloose monetary settings.

Data earlier this month underscored the economy’s ongoing need for support. Gross domestic product grew an annualized 0.2 percent in the quarter ended in September from the previous quarter, stuttering from a 1.8 percent expansion in April-June as exports fell amid trade tensions and a shopping surge before a two-point sales tax hike ran down stockpiles of goods.

Speculation among economists of extra BOJ stimulus in the coming months has cooled since the central bank changed its forward guidance rather than take action in October. That decision further indicated the high hurdle for additional easing, though BOJ-watchers warn that the bank could still move if the U.S.-China trade war takes a turn for the worse or financial markets slide, causing a jump in the yen. Kuroda said in both speeches that he was willing to take extra action if needed.

In the Diet last week, Kuroda said there was still room to lower interest rates further but added he had never claimed the BOJ’s easing ammunition was endless or that there was no limit on how low rates could go.

Fiscal persuasion

Fiscal policy has always been one of the “three arrows” of Abe’s economic-rejuvenation program, with monetary easing and structural reform being the other two. But it has something of a checkered history.

Spending in the 1990s was assailed for being wasteful and politically driven, and it left a legacy of the world’s largest public debt burden. This led to two hikes in the consumption tax, from 3 percent to 10 percent, under Prime Minister Ryutaro Hashimoto and subsequent leaders starting from 1997.

Kuroda, 75, was a Finance Ministry bureaucrat for most of his career and reinforced an impression of emphasizing fiscal discipline early in his tenure at the BOJ, when he endorsed the first of those tax hikes. Lawrence Summers, the ex-U.S. Treasury secretary, later quipped that you can take the man out of the ministry, but can’t take the ministry out of the man.

But Kuroda’s ascent there was through the International Bureau, not the Budget Bureau, which is the nerve center of fiscal austerianism in Tokyo. After leaving, he gained a broader perspective on policy coordination working at the Cabinet Office, where top aides to the prime minister work with associated senior staff.

Leaving that post in 2005, Kuroda literally wrote the book on coordinating monetary and fiscal efforts. His “Success and Failure in Fiscal and Monetary Policy” faulted the BOJ for failing to act in coordination with the government to address Japan’s slump into financial crisis and economic stagnation.

BOJ board members certainly haven’t ruled out further monetary measures, and actions such as accelerating asset purchases are still on the table as well. At the same time, they have clearly been reticent to follow peers across the world in easing policy this year. For some, that’s a hint the days of shock and awe from Kuroda’s BOJ are over.

“It must be a widely shared view at the BOJ that fiscal policy has to take a lead in the next recession,” said Kazuo Momma, a career BOJ staff member who served in roles including executive director for monetary policy and left in 2016. “The government also understands that the BOJ is approaching its limits after being so aggressive, and it’s becoming too much to ask more. You haven’t heard from politicians calling for more action by the BOJ for a while.”

Kazuo Momma, a former career BOJ staffer, says the government understands that the BOJ is approaching its limits after being so aggressive and that it’s becoming too much to ask more.  | BLOOMBERG
Kazuo Momma, a former career BOJ staffer, says the government understands that the BOJ is approaching its limits after being so aggressive and that it’s becoming too much to ask more.  | BLOOMBERG

Diet’s change of attitude

As Momma says, changed attitudes are evident in the Diet. For years, lawmakers would badger BOJ officials called up to the Diet, criticizing them for not doing enough to support the economy. Before Kuroda took office in 2013, there was even talk of revamping the law governing the central bank. Those days are long gone.

Kuroda was instead asked in a Nov. 13 Diet appearance about Modern Monetary Theory, which says countries can be confident in deploying government spending if they borrow in their own currencies and inflation is subdued (both conditions apply in Japan). The central bank chief said there was no such basis for such a theory, and the government last month underlined in a statement that MMT isn’t the foundation for discussing spending. That release also stressed “we are working to restore fiscal health.”

For all its big-debt reputation, Japan has actually steadily tightened the fiscal screws over the years — including through the introduction of an individual tax-identification number. Its deficit as a share of gross domestic product has hit the lowest in a quarter century, at less than 3 percent.

Continued reluctance to deploy that fiscal firepower can be seen in the limited supplementary budget the Abe administration is currently assembling to address damage from a recent pair of typhoons and the tax hike in October. Much of it is expected to be repackaged appropriations that were previously approved, rather than net new spending.

“Fiscal policy has the capacity to be effective, what’s lacking is the will to deploy it” in force, says Izumi Devalier, head Japan economist at Bank of America Merrill Lynch in Tokyo. “For those very reluctant to lean on fiscal policy, it’s going to be a choice between pushing the financial system further beyond the limit — pushing on a string — or doing fiscal stimulus,” she said.

Though Japan’s financial system is far from crisis, strains are intensifying as a result of the nation’s prolonged experience with rock-bottom interest rates. Ten-year Japanese government bond yields have averaged just under 1 percent since the start of 2000, compared with 2.7 percent in Germany and 3.4 percent in the U.S.

Such low yields have gradually pushed institutional investors and regional banks out of the JGB market and into riskier assets. Many analysts see bankruptcies looming among beleaguered regional banks, where the old model of borrowing short and lending long has been upended both by a flat yield curve and a diminished demand for credit.

Side effects

Worries about the downside of mega-monetary expansion surged in 2016, the last time that Kuroda surprised with a big new policy-easing move. The shock introduction of a negative short-term policy rate stoked howls of protest from the banking industry. It also set off such a precipitous decline in long-term bond yields (10-year rates hit minus 0.30 percent) that the BOJ overhauled its entire policy framework months later, targeting 10-year bond yields at around zero.

“Side effects were becoming larger and it was a sign that the BOJ was hitting its limit,” Hamada says of that period. “Nowadays when I meet Prime Minister Abe, I advise him to use fiscal policy.”

Kuroda himself still argues that momentum toward his inflation target is in place. And two of the BOJ’s current board members consistently dissent in favor of stronger action. But such calls are now lonely voices in a capital where the increasing focus is on how to limit damage to the financial system.

“Abe and most Liberal Democratic Party members have given up on the original reflation policy — stimulus only through monetary policy boosting growth and inflation, raising tax revenue,” says Shigeto Nagai, chief Japan economist at Oxford Economics in Tokyo, who previously worked at the BOJ. “That dream has disappeared.”

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