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People are reflected on a glass window at a shopping mall in Tokyo on Nov. 30, 2012. Japan’s core consumer prices stayed flat in October from a year earlier, government data showed, emerging from negative territory for the first time in six months but the economy has a long way to go before achieving the Bank of Japan's inflation target of 1 per cent. (YURIKO NAKAO/REUTERS)
People are reflected on a glass window at a shopping mall in Tokyo on Nov. 30, 2012. Japan’s core consumer prices stayed flat in October from a year earlier, government data showed, emerging from negative territory for the first time in six months but the economy has a long way to go before achieving the Bank of Japan's inflation target of 1 per cent. (YURIKO NAKAO/REUTERS)

Bank of Japan weighs ‘big bang’ war on deflation Add to ...

Bank of Japan Governor Masaaki Shirakawa was feeling the heat in February when he was summoned to parliament five times to explain what he planned to do to get Japan out of its deflation doldrums.

Mr. Shirakawa tried to defend his cautious approach to easing monetary policy, but his tremulous voice was often drowned out by jeers from the benches. “We need a new governor,” one MP shouted during one session. Some angry lawmakers even questioned whether the Bank of Japan should retain its independence from the government.

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Mr. Shirakawa had been opposed to another round of policy easing, though most members of his policy board were actually arguing for it at that time, according to sources familiar with the bank’s internal discussions.

The threat from lawmakers to withdraw the BOJ’s charter granting its independence was what changed his mind, the sources said. So the central bank surprised the markets in February by setting an inflation target for the first time of 1 per cent and announcing a $122-billion (U.S.) increase in its asset-buying program.

Those five days of intense grilling and the ones that have followed have been among the most intense ever faced by a Japanese central bank governor. Mr. Shirakawa has been summoned 29 times so far in 2012, a decade-long record. And the pressure is having a big impact: it was the catalyst for a radical rethink in central bank policy. The full effect of that pivot is expected after April when Mr. Shirakawa is due to step down, according to more than a dozen interviews with those involved in the process.

“The central bank, as an institution, was under threat and people there were getting pretty desperate, feeling that something had to be done,” said a former BOJ official who remains in touch with central bank executives.

The 63-year-old Shirakawa, a University of Chicago-trained economist, insists monetary policy can have only a limited impact in the battle against persistent deflation that has come to define two decades of Japan’s economic stagnation. Pumping unlimited amounts of cash into the banking system or underwriting government debt, the solutions pushed by his critics, could thrust Japan into a financial crisis, he says.

But the terms of the debate are already changing within the BOJ’s nine-member policy board, where Mr. Shirakawa is now outflanked by newcomers who pushed - unsuccessfully for now - for a bolder commitment to an ultra-easy policy last month, minutes released by the board in November showed.

Members of the BOJ’s elite monetary affairs department have been drawing up plans for a bolder set of policy options since late last year, people with knowledge of those discussions say.

One unifying concern, many of those interviewed say, is a belief that in order to keep lawmakers from undermining its legal independence the BOJ needs to step into uncharted territory by running an ultra-loose policy for years to come.

Masaaki Kanno, a former BOJ official and now chief economist at JPMorgan Securities in Japan, said Shirakawa will go down in history as the last “normal” governor of the central bank.

“Shirakawa is unpopular because he tells the hard truth people don’t want to hear,” Mr. Kanno said. “He may not necessarily be the best cheerleader, but then, do we really want the central bank governor to be just a good cheerleader?”

Mr. Shirakawa has also become a lightning rod. With a series of headline-grabbing comments that jolted financial markets, Shinzo Abe, the former prime minister whose Liberal Democratic Party (LDP) is favored to return to power after a nationwide election on Dec. 16, has made BOJ bashing a centerpiece of his campaign.

Mr. Abe has called on the BOJ to set an inflation target of at least 2 per cent - doubling its current target - and to commit to open-ended monetary easing. Short-term interest rates should be set below zero, he has said, and the central bank should stand ready to buy all the bonds needed to finance public works investment from the market - an extreme step economists warn is dangerously close to “monetizing” debt, or directly underwriting debt from the government.

If needed, Mr. Abe also says, the 1998 law that granted the BOJ its long-sought independence should be rewritten.

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