The Bank of Japan’s 2 percent annual inflation target was set by the central bank and the government in 2013 as a yardstick in the unprecedented massive monetary stimulus program to end the deflation that had gripped Japan’s economy for years. Five years on, the inflation target remains elusive — even though the economy appears to be in pretty good shape. Gross domestic product had two full years of uninterrupted growth until it suffered an annualized 0.6 percent fall in the January-March period. Major companies continue to enjoy record profits, and the job market is now the tightest in decades. The economy is obviously no longer gripped by the deflationary spiral that the BOJ’s monetary stimulus sought to end.
And yet the central bank clings on to its 2 percent target, and it says the tweak of the monetary policy that was decided at its policy meeting this week is designed to make the policy more sustainable over the longer term — now that it’s deemed the inflation target will take longer to achieve than had been anticipated. The BOJ should review whether 2 percent inflation is really necessary for the economy going forward, especially given that the policy intended to achieve the target is causing some unfavorable side effects that needed to be addressed through the latest tweak.
When the central bank introduced the massive monetary stimulus five years ago, BOJ Gov. Haruhiko Kuroda was confident that the 2 percent inflation goal could be achieved within two years. Since then, however, the target date has continued to be pushed back. In its latest review of the economy’s prospects, the BOJ lowered its inflation forecast in fiscal 2018 from 1.3 percent to 1.1 percent, from 1.8 percent to 1.5 percent in 2019 and from 1.8 percent to 1.6 percent in 2020 — confirming that the goal is still nowhere in sight. The consumer price index in June, excluding fresh food, rose a mere 0.8 percent from a year ago. Kuroda admits that in order to achieve the 2 percent target, the large-scale monetary stimulus needs to be pursued longer than had been anticipated.
The monetary stimulus centered on the BOJ’s massive purchases of government bonds and other assets to inject more money into the economy and keep interest rates at ultra-low levels. While the program has shored up the economy, some negative side effects have become apparent as the policy became protracted without achieving the inflation goal.
One side effect is the decline in the functions of the bond market — where, because of the continuing large-scale purchases by the central bank, the volume of Japanese government bonds is insufficient to have transactions on the market. Another is the program’s impact on the financial health of financial institutions, whose profitability in the lending business has been damaged by falling lending rates under the extended easing policy. Concern has been growing that the declining profitability of banks, in particular the nation’s struggling regional banks, could either prompt them to resort to risky lending or become more hesitant to lend to their business clients and individual customers — exactly the opposite of what is intended in the monetary easing.
The latest adjustments to the BOJ’s policy, including greater flexibility in its long-term interest rate target, are explained as measures to make the policy more sustainable for a longer period by addressing some of its negative side effects. Behind the move is the BOJ’s commitment to keeping the massive monetary stimulus until the 2 percent inflation goal is achieved — which it now admits will take much longer than it had anticipated. But given the state of the economy today, two questions should be asked: Should the 2 percent annual inflation rate still continue to be enshrined as a BOJ policy target? And is the current policy indeed the right tool to achieve that?
As to why inflation has not risen despite Japan’s growing economy, the BOJ cites a combination of multiple reasons, including the lingering mindset and practices of consumers and businesses that assume that prices and wages will not significantly rise; the large room left for increases in productivity, mainly in the non-manufacturing sector; and the relatively low wages of women and elderly workers who have entered the labor market in greater numbers. These are all structural problems of the economy that large-scale monetary easing alone will likely not resolve anytime soon. Serious thought should be given to the question of whether a continuation of the current BOJ policy will fix them.