On March 19, the Bank of Japan decided that it would focus more on money supply than on interest rates and that the new policy would be continued until it was confident that the consumer price index, which has been declining continuously for over two years, was rising.
I believe that the decision was correct for the following reasons.
First, it has at last been recognized by the authorities that the present complications of the Japanese economy are closely related to the unusual development that prices have been declining for a considerable period. There have may have been times in the past when the wholesale price alone declined for some years, reflecting, for example, successful restructuring of the distribution system. But there have been few, if any, cases of prices as a whole, including the consumer price, continuously declining over a long period.
Unfortunately, we do not have a general economic theory based on declining prices, to say nothing of economic policies based on it. Actually, the present structure of the economy, patterns of business behavior and official economic policies all assume that prices do rise. So it is no wonder that the unusual development of declining prices has adversely affected the economy.
When a businessman accustomed to rising prices finds that sales figures for the past year have been flat, he is likely to judge, wrongly, that there has been no improvement in his financial situation even when in real terms sales may have increased. In these circumstances, the balance sheets of commercial banks deteriorate unjustifiably. As prices decline, banks have to redeem to their depositors, at the time of maturity, more than they received as deposits.
If the policy to stabilize or lift prices succeeds, the economy will be rid of these complications.
Second, it has become clear that the issue at present is more monetary in nature than concerned with the real side of the economy. By successfully increasing prices, hopefully by increasing the money supply, a good portion of the present complications would be resolved.
The new bank policy has two implications for the nation’s future economic policies.
First, we may refrain, for now at least, from preparing stimulus policies aimed at increasing aggregate demand — a reasonable conclusion if one admits that the present problem is basically a monetary one.
Second, we must address issues related to the stock of the economy, since prices crucially affect the value of existing assets and property. It may, for example, be a good idea to reassess how measures being implemented as a part of so-called restructuring efforts affect the existing stock.
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