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Change of the Guard--And the Deflation Storyline--At the Bank of Japan

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Change of the Guard--And the Deflation Storyline--At the Bank of Japan Economic Research: Change Of The Guard--And The Deflation Storyline--At The Bank of Japan Credit Market Services: Paul Sheard, Chief Global Economist and Head of Global Economics and Research, New York (1) 212-438-6262; [email protected] Table Of Contents A Battle Of Words--And Ideas Abe-Nomics And Bureaucratic Politics Paving The Way For The Consumption Tax Hikes A Big Bureaucratic Prize Some Other Tidbits Prepare For Action A Matter Of Priorities Endnotes Related Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 28, 2013 1 1106030 | 301001947 Economic Research: Change Of The Guard--And The Deflation Storyline--At The Bank of Japan (Editor's Note: The views expressed here are those of Standard & Poor's chief global economist. While these views can help to inform the ratings process, sovereign and other ratings are based on the decisions of ratings committees, exercising their analytical judgment in accordance with publicly available ratings criteria.) The press conferences of the outgoing governor of the Bank of Japan (BOJ), Masaaki Shirakawa, on March 19, and of the new governor, Haruhiko Kuroda, and deputy governors, Kikuo Iwata and Hiroshi Nakaso, on March 21, provided both interesting contrasts and encouraging signs for those banking on a successful reflation by the BOJ. Put simply, the governorship of the BOJ has passed from a central banker who professed not to believe that the BOJ has the ability to end deflation in Japan to one who argues that it does. That does not guarantee deflation-fighting success, but it establishes the most important precondition for it. A central bank whose core view is that ending deflation is beyond its direct control is almost bound to fail (to end deflation) and thereby have its pessimistic assumptions reinforced. One that rejects that view at least has a chance. Overview • The change in the leadership of the BOJ, in the context of Prime Minister Abe's push to reflate and revitalize the Japanese economy, represents a watershed. • Whereas former governor Masaaki Shirakawa saw appropriate monetary policy as a necessary condition for ending deflation, new governor Haruhiko Kuroda and new deputy governor Kikuo Iwata see aggressive monetary policy as a sufficient condition. • It is unclear yet whether the Abe-inspired reflation push is what it seems, or whether it is part of a larger, complicated set of maneuvers to help fiscal hawks keep on track the consumption tax hikes slated for 2014 and 2015 and the Ministry of Finance to reassert influence over the Bank of Japan. • If the former, it is highly positive; if the latter, less so. Policymakers may care more about appearing to focus on ending deflation than actually doing so. A Battle Of Words--And Ideas At his press conference, Mr. Shirakawa reiterated his view, which had become the pillar of BOJ orthodoxy and its core message under his governorship, that the BOJ alone could not end deflation: "For my part, I have made every effort towards ending deflation and securing sustainable growth under price stability, but in order to achieve these objectives powerful monetary easing by the Bank of Japan and efforts by a wide range of agents to strengthen competitiveness and growth potential is essential" (1). He went on: "What we want to bring about is a picture where the real economic growth rate rises--although in a declining population society that may be the growth rate of per capita real GDP or GNI--and as a result the rate of inflation rises." In other words, monetary easing alone is not sufficient-- only with the WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 28, 2013 2 1106030 | 301001947 Economic Research: Change Of The Guard--And The Deflation Storyline--At The Bank of Japan help of the government in implementing growth-enhancing structural reforms, and of the private sector in making use of them, can deflation be brought to an end. Mr. Kuroda appears to reject this line of reasoning and, importantly, is prepared to let that be known. He began his press conference with a clear message: "In assuming the governorship, let me say one thing. The Japanese economy has been suffering from deflation during nearly the past fifteen years. I think the most important mission of the Bank of Japan is to end deflation and to achieve its price stability target of 2% as soon as possible." He went on: "It all boils down to the Bank of Japan achieving its 2% price stability target as soon as possible. In that case, looking at conditions in various countries, many central banks regard about two years as one kind of time span for achieving their price stability target. Taking this kind of thing into account, I think it is extremely desirable for the price stability target to be achieved in about two years. Next, there is the question of what means to use, but I think this really just boils down to implementing further quantitative and qualitative easing. Quantitative easing is certainly indispensable, but we should achieve the 2% price stability target--and I am confident it can be achieved--not just by increasing the monetary base, but by implementing aggressive monetary easing from both the quantitative and qualitative angle, on the asset side [of our balance sheet] by lowering the whole yield curve and as necessary eliciting a lowering of risk premia." Deputy Governor Iwata (2), a long-time critic of the BOJ and advocate of inflation-targeting and aggressive quantitative easing to end deflation, was even more forthright. Not mincing words, he stated: "In order to achieve 2% inflation or to escape from deflation, I think two conditions are necessary. The first is that the Bank of Japan should commit to roughly by when it will take responsibility for achieving its 2% inflation target. Committing to this is extremely important. … Averaging [the results of various research] the inflation target is [sought to be achieved] in about two years so I am saying ['within two years'] from that experience. Second, in that sense, because we are committing and taking responsibility to achieve [2% inflation] within about two years, in the event that we cannot achieve it, it is best not to make excuses such as 'it is not our fault,' 'the causes lie elsewhere.' Unless we adopt this kind of stance, the market will not put faith in our monetary policy. If the market does not put faith in monetary policy, no matter how much you cut the interest rate or do quantitative easing there will not be much effect--that is my stance." Underlying this difference in views between Mr. Shirakawa on the one hand and Mr. Kuroda and Mr. Iwata on the other as to whether the BOJ has it within its power to end deflation is a difference in opinion regarding whether the central bank can or should try to directly influence the public's inflation expectations. That a central bank should try is a central tenet of the modern inflation-targeting approach adopted by most central banks. If the public believes that the central bank has the tools to achieve its inflation target and is determined to use them to that end, it is rational for the public to expect future inflation roughly in line with the rate of inflation that the central bank is saying that it wants to achieve. This potentially virtuous expectations-influencing cycle--if it can be harnessed--makes the central bank's job that much easier. This is why central bankers such as Ben Bernanke, Mervyn King, and Mario Draghi are always banging on about the importance of "transparency," of "good communication" and, most notably, of "anchoring inflation expectations." Mr. Kuroda clearly buys into this paradigm. Asked about the transmission channel of aggressive quantitative and qualitative easing to the real economy, he noted: "In addition, the influence of 'expectations' or 'forecasts' cannot be ignored. Particularly under zero interest rates, when short-term rates are pegged almost at zero, in undertaking WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 28, 2013 3 1106030 | 301001947 Economic Research: Change Of The Guard--And The Deflation Storyline--At The Bank of Japan quantitative and qualitative easing the role that expectations play and [the central bank] working on expectations is actually extremely important. … In the case of deflation, by weakening deflation expectations the effect of monetary policy is greatly enhanced." Contrast this with Mr. Shirakawa's dim view of the central bank trying to achieve its target by acting directly on the public's inflation expectations: "When it comes to exiting from deflation, what we want to achieve is not just a rise in the price level, but, as I have repeatedly said, 'achieving an early end to deflation and sustainable growth under price stability.' The living standards of the Japanese people are hardly going to improve just because the price level goes up 2% and incomes go up at the same rate." And later: "If 'working on expectations' is taken to mean 'the central bank moving the market at will by its words,' I feel danger in that kind of market view or policy view." For his part, Mr. Nakaso did not go as far as Mr. Kuroda and Mr. Iwata in drawing a line between the new and the old leadership; that is a difficult balancing act for a 35-year BOJ veteran and most recent assistant governor. But he signaled that he was on board with the "new BOJ." He opened by saying: "I will earnestly try to contribute to achieving the mission of the Bank of Japan of maintaining price stability and financial stability by supporting Governor Kuroda and joining forces with Deputy Governor Iwata." He reflected: "I think we have to take seriously the fact that we still have not overcome deflation, we have not achieved that result.
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