Bank of Japan Gov. Haruhiko Kuroda, as he began his second five-year term this week, reiterated his resolve to do all he can to achieve the annual 2 percent inflation target, which was set as a yardstick in the joint efforts by the BOJ and the government to bust deflation when he took the helm of the central bank in 2013. Five years on, that goal — which he was initially confident of achieving within two years — remains elusive. The question that now should be asked is whether the target needs to be maintained and tied to an exit from the BOJ’s massive monetary stimulus.
The economy is in good shape, with gross domestic product expanding for eight quarters in a row through the October-December period. As the Kuroda-led BOJ maintained its unprecedented program of monetary easing, corporate earnings and employment conditions improved significantly. Combined profits of major listed companies are estimated to have set record highs for two years in a row, although they continue to rely on a weak yen and brisk demands in overseas markets. The jobless rate has hit a 24-year low, while the job market is at the tightest level since the mid-1970s. Although the rise in consumer prices in the latest monthly data is just halfway to the 2 percent inflation target, it seems certain that the economy is no longer gripped by a deflationary spiral in which persistent declines in prices depress economic activities.
Kuroda maintains that it is premature to discuss an exit strategy, noting that the 2 percent inflation target is still too far off. True, the economy faces risks, notably the recent pickup in the yen’s value and the threat of a trade war from the administration of U.S. President Donald Trump, which has embraced hawkish protectionism. In the BOJ’s latest tankan survey, the business sentiment of large manufacturers took a turn for the worse for the first time in two years. A hasty discussion of an exit from the monetary easing might indeed sow seeds of confusion in the market.
Still, it needs to be debated whether the 2 percent inflation target — which has been repeatedly pushed back to the point where its practicality is being questioned — should continue to be pursued. The BOJ’s monetary stimulus through its massive asset purchases has had negative side effects. Its prolonged ultra-low interest rates have weighed heavily on the earnings of banks by way of cuts to lending margins, and are deemed to have loosened the government’s fiscal discipline. In weighing the wisdom of maintaining the inflation target, the central bank should reassess the current conditions of the economy, which continues to expand without a significant increase in prices.
Prices are indeed rising — but not necessarily in favorable ways from the viewpoint of consumers. The consumer price index in February was 1.0 percent higher than a year ago — the steepest rise in 3½ years — for the 14th straight monthly increase. However, a large portion of the price gain remains attributable to increases in energy-related costs such as gasoline prices and electricity rates. Prices excluding perishables and energy rose a mere 0.5 percent in February.
This month prices rose on a broad range of goods and services — including beer, fermented beans, beef bowls, cigarettes, parcel delivery charges and electricity — mostly due to increased costs of raw materials and energy, manpower and distribution expenses. Meanwhile, wage negotiations this spring do not appear to have produced the sharp pay raises expected in view of the steep gains in corporate earnings.
Price increases are good for the economy when they rise as a result of increased economic activity such as consumption generating more demand. But price hikes as a result of increased material and other costs can dampen demand and drag down the economy. The recent price increases appear to be more an outcome of rising costs than heated demand. Despite the economy’s sustained expansion, the recovery in consumer spending has been uneven and weak as wage growth remains stagnant. The per capita wage income of workers fell 0.2 percent on a net, inflation-adjusted basis last year as prices rose faster than wages. Consumers might be tempted to reduce spending if price increases offset their wage gains.
The BOJ set the 2 percent inflation target as a means of achieving steady economic growth. The government and the central bank say they will mobilize all policy tools to achieve the targeted inflation. But they should also consider whether the policies they take are resulting in the kind of price increases that generate a virtuous cycle in the economy.