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Throwing down the gauntlet

11 January 2013 By Andy Mukherjee

Japan’s new prime minister has thrown the country’s central bank a $117 billion challenge.

Shinzo Abe’s government took the lead in the fight against deflation on Jan. 11, announcing its biggest fiscal stimulus package since the 2008 crisis. That leaves the Bank of Japan with no excuse to delay adopting a stiffer inflation target than the 1 percent annual price increase goal it is currently pursuing.

The central government’s 10.3 trillion yen spending boost, which it expects to lift real economic growth by 2 percentage points, will require it to issue a further 5 trillion yen of sovereign bonds in the current fiscal year. More borrowings will come later. To prevent risk-free yields from rising, the central bank will have to mop up the excess supply from the debt market using newly printed money. An increase in the BOJ’s 101 trillion yen asset purchase program at its next monetary policy meeting on Jan. 21-22 now looks a foregone conclusion. Doubling the central bank’s inflation target to 2 percent, which Abe has been pushing it to do, is also almost certain.

But while the combination of government spending and money-printing represents a step in the right direction, coordination between fiscal and monetary authorities on exchange rate targeting might help the economy more.

Holding the yen’s exchange rate down at about 100 to the dollar – about 12 percent weaker than the current level – would boost Japanese exports, which have suffered a severe loss of competitiveness in recent years. Stronger exports would lift employment and wages, which in turn would put upward pressure on prices. Exchanging printed yen for dollars would also engineer higher expectations of inflation by boosting the money supply.

But in Japan, the finance ministry decides currency intervention, while the central bank prints money. Pending coordination between the two authorities, Abe has done the best he can.

The stimulus will further increase the public debt, which is already an eye-watering 237 percent of GDP. But to have shied away from additional fiscal spending would have been a mistake. Abe’s prognosis is quite right: without an economic revival Japan will neither have fiscal consolidation, nor much of a future.


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