In a dramatic policy reversal, the Bank of Japan has shifted its priority from cutting interest rates to expanding the money supply. The shift involves changing the key target for monetary adjustment from uncollateralized call-money rates to private banks’ demand-deposit balances in the central bank.
Under the new formula, the outstanding amount of these interest-free deposits will be increased by 1 trillion yen to 5 trillion yen. The increase effectively brings the call-money rate to zero. The BOJ says it will continue this quantitative easing until year-on-year changes in consumer prices reach zero or higher. The BOJ will also increase, if necessary, purchases of long-term government bonds, now totaling 400 billion yen a month.
BOJ Gov. Masaru Hayami described the shift as a “drastic measure that is not normally taken.” Finance Minister Kiichi Miyazawa welcomed the move, saying the Bank of Japan “has done everything it can.” With an easy-credit policy now in full force, he added, “deflationary psychology” — expectations of continuing price declines — will go away. The market has reacted positively.
The Bank of Japan has set a sort of deadline for quantitative easing by using the consumer price index as a benchmark. This is a big step forward in the sense that it provides an easy-to-understand basis to make and evaluate policy. However, the price target — consumer prices remaining flat or rising on an annual basis — is a little vague. A more specific target — say, 1 or 2 percent increases — would make it easier to decide when to end the policy.
Last August the BOJ lifted the zero-interest-rate policy by raising the key overnight call-market rate (the rate at which banks borrow from each other). Clearly, that decision was mistaken. The central bank had been guided by the imagined effectiveness of interest-rate adjustment and by the unrealistic perception of inflation risks.
The government and the ruling parties have been just as wrong in their analysis of the economic situation. They have continued the stopgap spending policy that sacrifices fiscal discipline and has inflated the government debt to catastrophic proportions. Private banks have also put off hard decisions because of their inability to clean up their bad debts and let go of debt-swamped clients.
The Bank of Japan cannot escape accountability for the policy reversal. But the government and the ruling parties, as well as government-dependent banks and heavily indebted corporations, bear greater responsibility. The BOJ is quite right to urge banks to clear their bad debts. It also has every reason to call for a “clear-cut public willingness” to support “painful structural reforms” in the economy and “strong leadership” on the part of the part of the government.
Now, banks have no choice but to speed up debt writeoffs. Shakeups of debt-heavy corporations — drastic restructuring under the industrial rehabilitation law, for instance — are also unavoidable. The ruling coalition has already put together a package of emergency measures, including creation of a private-sector fund to buy up surplus shares, reduction of the capital gains tax on shares and the dividend tax on individual shareholders, and expansion of real estate liquidity. Tax reform should aim chiefly at luring huge personal savings into the securities market.
Drastic bank and business restructurings will throw more people out of work. So there is an urgent need to take ad hoc measures to combat rising unemployment. It is also essential to step up efforts to improve and expand the “safety net” with priority given to long-term job creation. In addition, inefficient government spending that has little demand-creating effect, as well as the bloated fiscal investment and loan program (the so-called second government budget), should be overhauled. Full deregulation is also indispensable.
However, all of this is too late, if not too little. It is a pity that Prime Minister Yoshiro Mori, in his meeting last week with U.S. President George W. Bush, was reminded of the pressing need to clean up the bad-debt mess and move ahead with painful structural reform. The Bush administration has said it will not lecture Tokyo on how to run the economy. With the U.S. heading into a recession and with Japan mired in a deflationary slump, however, Bush seemed to have no choice but to prod Tokyo to act.
The worry at home is that the measures now in the works, if implemented in haste without a well-defined strategy, might encourage fiscal profligacy among politicians and moral hazard among banks and businesses. Should this become reality, the Japanese economy would degenerate into a really hopeless situation.
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