Prime Minister Junichiro Koizumi said recently the next governor of the Bank of Japan must take aggressive action to fight deflation, giving rise to expectations of inflation targeting among government and ruling coalition officials. I doubt, however, that inflation targeting will cure deflation. In March 2001, the BOJ raised the balance of commercial banks' current deposits with the central bank to 5 trillion yen to enable banks to increase loans. Continued pressure for easier money from the political community and mass media prompted the BOJ to raise the amount to 6 trillion yen and then to 7 trillion yen, a former BOJ official recalled. The amount now stands between 15 trillion yen and 20 trillion yen, but bank loans have kept decreasing and business investment remains sluggish.
The government has been trying hard to expedite the disposal of banks' non-performing loans. Undoubtedly, it is necessary for banks and companies to restructure their balance sheets, but that does not guarantee recovery in capital spending.
In fact, companies without balance-sheet problems are moving their production plants overseas, which means a decrease in domestic investment. Low-cost imports from their overseas plants have deflationary effects on the economy. Increased supply of and decreased demand for land lead to a drop in land prices.