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Aiming higher

22 January 2013 By Andy Mukherjee

After more than a decade of feigning helplessness against falling prices, the Bank of Japan has finally signed up for combat duty.

Armed with a 2 percent inflation target, twice the 1 percent goal it has been half-heartedly pursuing since February last year, the central bank will now lead Prime Minister Shinzo Abe’s battle to reverse the country’s endemic deflation.

To demonstrate its commitment to reaching the objective, which the government wants the BOJ to achieve as soon as possible, the central bank has agreed to buy 13 trillion yen ($145 billion) in yen-denominated assets each month, starting in 2014. In terms of sheer size, that makes it even more aggressive than the U.S. Federal Reserve’s $85 billion-a-month quantitative easing programme.

Yet the bold money-printing plan suffers from two potential drawbacks. First, it doesn’t start for almost twelve months. And second, while further weakening the yen could help Japan’s export-dependent economy, the BOJ still needs to persuade markets that it won’t abruptly give up the fight. Given the central bank’s past track record, that will be quite a challenge.

Unlike the BOJ’s current 101 trillion yen asset-purchase plan, which is set to end in December, the new approach is open-ended: The BOJ says the programme will continue as long as it is deemed “appropriate.” But the crucial questions are: Under what conditions will the hyper-easy monetary policy become inappropriate? When would the purchases stop, and when might the BOJ start selling?

The central bank needs to convince investors that even when its strategy has succeeded in fuelling inflationary expectations, the BOJ won’t tighten policy hastily – which is what it did in 2000 and 2006. One option could be to tie the size of the BOJ’s balance sheet to policy makers’ inflation forecasts. Until the average forecast breaches a ceiling of, say, 3 percent – above the official target – the BOJ would refrain from mopping up liquidity.

Unless investors are persuaded that the money the BOJ is pumping out into the economy won’t be drained at the first whiff of inflation, the deflation enemy will be hard to defeat.


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