The U.S. Federal Reserve has exported its nascent monetary-policy revolution to Japan.
Japan’s central bank, an institution that has looked timid and impotent for years thanks to its two-decade battle with falling prices, Tuesday declared that “for the time being,” anything it does is designed to generate 1 per cent inflation. It will attempt to do this by adding another ¥10-trillion ($128-billion U.S.) to an already massive program of financial asset purchases, in a bid to revive demand in a long struggling economy.
The move to adopt an inflation target may not seem so significant at first glance, since the Bank of Japan already had a stated understanding that so-called price stability should be defined as annual price increases between just above zero and 2 per cent. But if you look at this in the context that the central bank took until late 2009 even to formally recognize that deflation was a big problem, then by policy standards it is a big deal.
As Dean Baker of the Washington-based Centre for Economic and Policy Research notes, the idea is that if the BOJ “can credibly commit itself to a higher inflation target, then the commitment could create self-fulfilling expectations,” meaning businesses would invest and consumers would spend because they think prices will be higher later, and that investment and spending would spark the inflation.
The shift comes not only in response to dreadful economic conditions, but also to escalating pressure from frustrated politicians who have urged BOJ Governor Masaaki Shirakawa to be clearer about what he is trying to achieve with a range of extraordinary policies that seem to have done precious little good. (Indeed, Carl Weinberg of High Frequency Economics points out in a research note that since the late 1990s, Japan has experienced inflation of 1 per cent or higher for just a few months in early 2008, and that was because global energy prices were soaring.)
Regardless of whether the BOJ’s move will succeed, it shows Mr. Shirakawa and his officials have been paying close attention to the push for greater transparency in monetary policy, a cause whose somewhat improbable champion has been the U.S. Fed.
Japanese politicians noticed last month when Fed chairman Ben Bernanke announced that his central bank was adopting a formal inflation target (2 per cent). The Fed move was in part meant to quiet critics in the U.S. Congress who have fretted that in leaving interest rates at rock-bottom levels for years and pushing unconventional policies, such as his own asset-purchase programs, Mr. Bernanke was blindly risking runaway inflation. Mr. Shirakawa faces a mirror image of that criticism, with increasing calls for him to do more to slay the deflation dragon, and Economy Minister Motohisa Furukawa recently musing that the BOJ may need to make its stance on prices clearer.
The Fed, meanwhile, has not only adopted an inflation target, but has also started publishing interest-rate forecasts from its 17 officials who influence policy. Again, the added clarity – a revolutionary split from the Alan Greenspan-era belief that monetary policy is strengthened by retaining some surprise – is meant to spur economic activity, by giving businesses and consumers some certainty about what the Fed will do and for how long, even if the forecasts are more guidance than a solid promise.
Academic research and the experience of central banks outside the U.S. – such as the Bank of Canada – suggest there is a link between economic growth and relative certainty about the central bank’s intentions for inflation and, by extension, interest rates. (Mr. Bernanke has favoured more transparency at the Fed since he first joined as a governor in 2002, but only recently got his way.)
When economic conditions are taking forever to improve and executives and households are gripped with uncertainty, clear communication about what a central bank hopes to achieve, why and by when, may be the most effective weapon it has at its disposal. Even though politicians wasted little time in blasting the BOJ’s target as too low (i.e., timid), and even though the country faces problems that a central bank arguably can’t do much about – like its rapidly shrinking working-age population – taking a page from the Fed’s playbook just might end up being the smartest thing Mr. Shirakawa and his crew have done in years.
With files from Brian Milner