With the war in Iraq clouding economic prospects, the immediate task for the new governor of the Bank of Japan, Mr. Toshihiko Fukui, is to shore up sagging confidence in the nation’s economy, particularly the financial system. In this respect, he has made a good start. Several days after he took office on March 20, the BOJ decided to pump an additional amount of money into the banking system and to expand its purchase of stocks held by banks.
The central bank’s willingness to “take every step to ensure financial market stability” is welcome. The bank is often associated with an image of passive decency, the implication being that it is not disposed to bold action. Now is the time to project a more positive image. Of course, there are limits to what it can do. Monetary policy will go over the top if demands from political and business circles are easily accepted.
It is important for the central bank to remain in close touch with the government, but it must do so in ways that do not hurt its autonomy. The two sides do not need to fight or blame each other, as they did in the past. The challenge for the new governor is to promote dialogue with the Finance Ministry and the Financial Services Agency so that monetary and fiscal policy can be conducted in an integrated manner.
Coordination is all the more important because options are woefully limited for both the government and the central bank. Fiscal policy is fettered by an enormous debt load that threatens a crash in bond prices, while monetary policy is shackled by zero interest rates, which leave quantitative easing — such as buying government bonds — about the only way to expand the money supply.
Of particular concern to both sides are falling stock prices, which dropped to a 20-year low earlier this month. The worry is that further price falls would weaken the capital bases of major banks and prompt them to squeeze lending to cash-strapped clients. The credit crunch, if combined with a rush of business bankruptcies, would spread a sense of crisis in the financial system and worsen the economic slump.
The BOJ has tried, without much success, a number of methods to bolster stock prices, such as buying shares held by banks and exchange-traded funds — clusters of stocks linked to market benchmarks such as the Nikkei average. The stock purchase plan has proved a halfway measure because banks are reluctant to sell when prices are falling. Buying ETFs could open the way to inflation targeting. Mr. Fukui is cautious about setting an inflation target; he says it is not the “magic wand.”
Essentially the stock market crash reflects a lack of confidence. Top banks have expanded their capital of late, but their stocks have dropped because investors don’t trust them much. Regaining market confidence is primarily the job of banks themselves, but managing a banking crisis is a vital role for both the FSA and the BOJ. In this sense, Mr. Fukui’s statement in the Diet calling for a mechanism for preventive bank bailout merits discussion.
The current Deposit Insurance Law allows the government to inject public money into ailing banks only when their collapse is deemed imminent. In other words, capital infusion is not authorized as a way of preventing an anticipated crisis. Experience suggests that preventive bailout may be a better way of dealing with troubled banks not only because they could be expected to get back on their feet early on, but also because the very existence of such a scheme would apply salutary pressure for bank reform.
More generally, fighting deflation remains the chief concern of the central bank as well as the government. This problem, however, needs to be addressed over the longer haul because a change in the industrial structure is needed to eliminate the causes of sustained price declines. Policy coordination must be strengthened to cure this chronic economic malaise.
The government appears to favor inflation targeting. In particular, Financial Services Minister Heizo Takenaka is known as a leading proponent. However, the BOJ remains cautious and should remain so. Basically Mr. Fukui should toe the line of his predecessor, Mr. Masaru Hayami, who warned of the danger of runaway inflation. This is also a question that requires closer dialogue between the government and the central bank.
Monetary and fiscal policies become intertwined when the central bank begins to print more money by directly buying new government bonds. That is also when inflation begins to rise, as the government loosens its grip on spending. The result would be an erosion of policy discipline on both sides. Avoiding that is the common responsibility of the government and the Bank of Japan.
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