The Bank of Japan and its independence When I was doing research for the Project on the Japan’s lost decade, I have come across news articles discussing the change in administration of the Bank of Japan. There are discussions on how Abe Shinzo, the newly elected prime minister, has forced the Bank of Japan to adopt a more aggressive monetary policy. When I first read about these news, I can’t help but felt sorry for the current governor Masaaki Shirakawa. By constitution, BOJ is independent from the government.
He should be answering to no one except to the Policy Board of the BOJ. But lately, Mr. Abe has forced the BOJ to bend towards what he demands. He even threatened to strip BOJ of its independence if it fails to raise the original goal of achieving an annual inflation target from 1% to 2%. But after reading into the history and development of Japan’s economy, I begin to understand why Abe has taken such extreme measure. The BOJ is not without fault. During the two decades of economic stagnation in Japan, the BOJ has clearly made some policy mistakes.
Since the key and only objective of the Bank is to maintain price stability, it is evident that the BOJ tend to act more prudently than it should be when the government is trying to revive the economy. Referring to Exhibit 1, Japan has never since the asset bubble burst in 1990s achieved an inflation rate of above 1% except for a short period of time in 2008. The economy was in a deflation mode for majority of the time and it could only be explained by two reasons.
Either the BOJ is not doing a very good job in controlling prices or simply, its actual inflation target has always been around 0%. Exhibit 1 Source: tradingeconomics. com Even after the BOJ has explicitly announced its inflation target of 1% last year in February, the actual inflation rate reported has been consistently below 0. 5%, with 8 out of the 12 months at the negative end. So, even BOJ has relented and agreed with Abe to raise its mandate to 2%, people didn’t expect the BOJ will gear up and work towards the revised goal right away.
The new asset purchase program which the BOJ rolled out in response to the government pressure is not exciting either. Although the BOJ has expanded its program to an open-ended one, the new measure will not take effect until 2014. In addition, the BOJ has continued to limit the asset class that it can purchase with a date to maturity of less than 3 years. It has essentially kept the existing QE program unchanged. As the saying goes “Extreme times call for extreme measure. ” People in Japan are already fed up with the zero grow economy.
Although current unemployment rate is low comparing to other developed countries and is showing signs of improvement since the 2008 financial crisis, the level of average disposable income for workers’ households with 2 or more persons in 2012 is still lower than the pre-financial crisis level. I believe Japan is in desperate need of a new leader who is determined to bring Japan out of the stagnation. This is why Mr. Abe won the campaign with a land-slide victory. Soon after Mr. Abe came into office, the BOJ and the government have made a joint announcement to renew their commitment to beat deflation.
However, many analysts believe that the BOJ has made the announcement, which is quite unusual, primarily to assert its independence after it has come under increased pressure from the government to step up its monetary policy. The statement contained a number of key declarations: “The Bank expects the Government to vigorously promote measures for strengthening Japan’s growth potential”, and “The Government expects the Bank to continue powerful easing … until deflation is overcome. ” The BOJ has clearly taken the opportunity to emphasize that it is the government’s own responsibility to fight deflation.
Nevertheless, I think it’s very noble of Mr. Shirakawa to defend BOJ’s independence and his own belief right to the last minute before leaving office. I believe the Policy Board has agreed to raise its inflation target more because many citizens have voiced out their support for Abe’s bold economic policy than the pressure they received. Mr. Shirakawa is stepping down voluntarily from office starting from mid-March 2013 to give way to the new BOJ governor. The Government’s nominee for the next BOJ Governor is Haruhiko Kuroda.
It comes in no surprise that he is an advocate of aggressive monetary easing during deflation times and unlike Mr. Shirakawa, he believes the Bank has a strong responsibility in bolstering economic growth. Hence, the market is expecting a series of new monetary policy to be announced soon after his appointment is approved. There is a strong and legitimate reason to keep the central bank independent from its government. Most of the central banks of the industrialized world adopt the same independence rule. It is to avoid politicians from ramping up government spending and debt whenever they want.
If politicians insist on continuing any ineffective government policy and have the central bank to buy up more assets, a decline in the asset price is going to left a hole in the Bank’s balance sheet. Central bank runs the risk of becoming insolvent and people would lose faith in the currency. Inflation would be out of control and it would be a disaster that no one would like to see. I still believe the independence of BOJ is of upmost important but I also believe the BOJ should willingly formulate its monetary policy with the overall economic conditions in mind besides considering the inflation rate.
Their policy should be more in-sync with other big policy goals of the country. Just like the US Federal Reserve, it includes “maximum employment” in the statutory objective for their monetary policy. The officials will just have to strike a balance between the two. Now that Haruhiko Kuroda and his new team are going to lead the BOJ, people has a very high expectation on what policy the new BOJ leadership is going to put forward. When the interest rate is already near zero and deleveraging in Japan is not yet completed, there is little the monetary policy could achieve when additional demand for borrowing is expected to be low, except for the BOJ to absorb most of new debts the government is going to issue for its fiscal stimulus.
The act is more about boosting investors’ confidence in the Japan’s economy as well as managing the expectation of the trend on inflation rate and on Yen, thereby encouraging more exports. To actually revive the economy in longer term, changes have to come from the government’s fiscal policy and long term structural reforms.
Could this time actually be different? It looks like that the government has a great start so far. The timing of the retirement of the BOJ officials couldn’t be any better. It marks the departure of the BOJ’s old practice, replaced by new leadership that shares a similar economic goal with the current government. Let’s hope that the two parties are able to follow through with what they have started and actually make a change to the Japan’s economy for the better.