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Yes, prime minister

12 Feb 2013 By Andy Mukherjee

Japanese Prime Minister Shinzo Abe’s war on deflation will soon have a new general. A hard-charging Bank of Japan governor with strong conviction and oodles of savvy could help bring Abe’s plan to fruition.

The leading candidates to replace Masaaki Shirakawa when he steps down in March are all impressive. Kazumasa Iwata and Toshiro Muto are former BOJ deputy governors. But having been central-bank insiders also carries with it the stigma of policy failures. Heizo Takenaka, who was point man for banking reforms under former Prime Minister Junichiro Koizumi, has a proven track record. Meanwhile Haruhiko Kuroda, the president of the Asian Development Bank, has a weighty Rolodex that might help Japan avoid international censure for its policies.

The nomination will have to be approved by both chambers of Japan’s parliament. But here are some interview questions the prime minister can use to test the candidate’s commitment to “Abenomics”.

Q. What will you tell critics who accuse you of debasing the yen?

Correct answer: Thank you. The new governor must eschew the puritanical notion that he must preserve the purchasing power of the Japanese currency. While that would indeed have been the job description in normal times, Japan is stuck in a deflationary quagmire. Only when people understand that their yen will be able to buy less, not more, tomorrow than today, will consumers spend more, employees demand higher wages and investors stop sitting on piles of cash or risk-free bonds.

Q. What will you do if inflation leads to higher interest rates and losses on BOJ’s holdings of public debt?

Correct answer: I don’t care. One of the reasons the BOJ’s response to deflation has been inadequate is because policy makers have agonised over the size and quality of the institution’s balance sheet. The new governor, too, will undoubtedly face warnings from hawks that a mere 5 percent drop in the value of the central bank’s government bonds will wipe out its capital. But running out of capital is a worry for private institutions, not a money-printing central bank.

Q. Won’t debt markets get jumpy if the BOJ chalks up large losses?

Correct answer: No. What matters to investors is the consolidated balance sheet of the government and central bank, and that will look better if higher inflation causes interest rates to increase. The $1.27 trillion of government paper held by the central bank is a fraction of the net outstanding public debt of about $7 trillion. Higher yields will reduce the present value of this liability. True, there will be pain at the state pension fund, whose assets are largely government bonds. But that problem will need a separate response.

Q. How will you allay the euro zone’s concerns that a weak yen is an assault on its competitiveness?

Correct answer: By buying Italian and Spanish bonds. To resist international opposition to a weak yen policy, the new governor should champion the Abe administration’s idea of a foreign bond fund. If the fund is large – say the equivalent of $500 billion a year – and a fifth of it is used to buy sovereign debt in the euro zone, about 5 percent of the annual gross borrowing requirement of all the governments of the single-currency area will find an assured lender. Under no circumstance, though, must Japan get dragged into another Plaza Accord, which led to a massive appreciation in the yen in 1986. That would risk extending Japan’s deflation.

The next governor’s place in history is assured. What remains to be seen is whether posterity views him as the peace-time hero who helped to end Japan’s chronic deflation or a failure like Masaru Hayami, who became governor in 1998 and did incalculable damage to the economy by refusing to believe – until it was too late – that Japan’s deflation was a bad thing.

A final question that Abe might want to slip in at the end of the quiz is: What will you do after I ratchet up deficit spending and rating agencies downgrade Japan again?

The correct answer: a shrug.


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