After slight resistance the BOJ did as told, calling a surprise policy board meeting in early December, and announcing it would inject up to 10 trillion yen in three-months loans to commercial banks at a rate of 0.1 per cent. BOJ governor Masaaki Shirakawa described the move as ‘quantitative easing in a broad sense’ and declared that the BOJ would not tolerate falling consumer prices. In March, the BOJ responded to further government pressure by increasing the programme to 20 trillion yen.
While these were moves in the right direction, they will not suffice to battle deflation. According to BOJ predictions, prices may fall for at least another two years. It is not clear from where the BOJ takes the confidence that deflation may end after two years. The BOJ appears to be hoping for the best, instead of developing new ideas to get the country out of the deflation trap. Yet hope might not suffice; the last round of deflation lasted much longer than two years, from March 2001 to June 2006. Overcoming it was helped by strong growth of the world economy that generated demand for Japanese exports, rising commodity prices and a modest yen. It would be foolish to count on a benevolent world economy to do the trick again. Rather, the BOJ, with the political support of the Japanese government, should develop a clear strategy that will prove its determination to reflate the economy and convince the Japanese public that it will succeed in overcoming deflation.
What needs to be done? First, the BOJ should develop and communicate to the public a comprehensive and credible anti-deflationary monetary policy strategy. This should not only include quantitative easing measures such as those implemented recently or the intensified purchase of government bonds, it should also set out a clear inflation target.
Second, the BOJ should underline its determination to pull out all the stops to meet this target by emphasising its willingness to employ even as unconventional measures as negative interest rates on banks’ balances if quantitative easing doesn’t do the job. Negative interest rates would not only push banks to lend out money rather than hoard it at the BOJ, they would also cause capital outflows and thus put downward pressure on the yen. A lower yen would help Japanese exports and thus economic recovery, and increase the cost of imports, which would bring about much-welcome inflationary pressure.
Third, if deflation persists, the BOJ could employ a further exceptional policy tool and do like most of its East Asian neighbours and intervene in the foreign exchange market to reduce the yen’s value. Whereas continued forex intervention to keep the yuan pegged to the dollar has caused unwanted monetary expansion and inflationary pressure in China, this would exactly be the desired effect of the Japanese intervention. Given the ministry of finance is in charge of the yen’s exchange rate policy, the intervention would need to be approved by the government. Of course, exchange intervention Chinese style would be a radical measure that would almost certainly trigger complaints from abroad. The ministry of finance should thus seek to find a cooperative solution with the Chinese, American and European partners to reduce the yen’s value – a move that might also deflect attention from the bilateral Sino-American currency dispute.
These three policy steps towards overcoming deflation would need to be supported by further fiscal expansion and broader economic reform measures by the Japanese government. While gross Japanese public-sector debt is already twice the size of the economy, the fact that 93 per cent of Japanese government bonds are held domestically (and partly through the BOJ and state-owned entities like the Japan Post Bank) means that auxiliary fiscal stimulus is unlikely to trigger a debt crisis.
While fiscal and monetary policies have important roles to play in overcoming deflation, the government must also embark on reforms of the notoriously rigid labour market and an education system that straightjackets talent and suppresses creativity. But maybe more than any of the aforementioned, the country needs to regain its dynamism and optimism: to help overcome the pessimism that has befallen the Japanese society and which is at the roots of the deflation problem, Japan needs to transform itself into a more child-friendly society.
Ulrich Volz is a Senior Economist at the German Development Institute.
This article was an entry in the recent EAF Emerging Scholars competition.
We can all be more creative and try something new, as opposed to try the failed old tricks.
Speaking of non-conventional measures, why aren’t economists more creative and bold in both domestic macroeconomic policy and international policy using a new kind of international monetary instrument to resolve domestic deflation problem existing in countries like Japan?
Just consider what the US has done (looking at the opposite and positive side), it is not too difficult for one to consider a policy from a deflationary country like Japan to lend to other countries specifically for them to buy Japanese goods and services with more favourable interest rates, as long as those lendings can be secured with very low risks.
If Japan is in a deflationary cycle, then it can stimulate other countries to provide sufficient demand for it and in turn stimulate its own production and demand in the process.
That is probably better than using and changing exchange rate.
I suggest an unconventional solution for Japanese government. I know they will not go for it, but nonetheless it is the only plausible monetary solution. What they need to do is to buy Chinese Yuan in massive amount, pay by Japanese Yen, not by US Dollars. This will give upward pressure to China’s currency which needs to appreciate, without giving US dollar a burden of downward drop. While Japanese yen has been steadily become the international transaction currency, they have not taken the constructive role in international monetary balance. Asia yen has to become global yen. That is the only way to push yen down, that makes the deflation in the country eased, and more growth inside the country.
5 years later and it hasn’t worked.