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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 ...

If it goes too far, some worry, it could trigger a loss of confidence and a debt crisis.

But among the firebreaks against runaway price increases is a banking sector that keeps pouring money into government bonds, rather than lending it out, and individuals who continue to save against uncertainty, rather than splurging. The same factors could give the BOJ more room to buy government bonds aggressively without igniting panic-inducing price increases, or so the argument goes.

Those who have worked for the soft-spoken Mr. Shirakawa describe him as a workaholic and a perfectionist. His few pleasures outside work include listening to the music of the Beatles and catching an occasional movie. A recent favorite: “Always Sunset on Third Street,” a 2005 drama that captures Tokyo on the cusp of economic boom in 1958.

Mr. Shirakawa joined the BOJ in 1972, months before inflation began sharply rising to near 25 per cent. The chaos of those months around the oil price shock was a formative experience for him, as was the “asset bubble” that formed in the late 1980s, people close to him say.

He was among the cadre of BOJ officials who masterminded the central bank’s previous spell of quantitative easing, which involved pumping vast amounts of money into the financial system. That spell lasted for five years until 2006 and helped Japan emerge from a domestic banking crisis. But he remains wary of the risks of that policy.

Mr.Shirakawa declined to be interviewed for this story.

One worrying trend Mr. Shirakawa and others have cited to support their caution over easing monetary policy was that much of the money the BOJ has injected into the economy recently has simply been piling up in bank accounts, rather than feeding into the productive economy via bank loans. That poses the risk of inflating financial assets, if the account holders plough it into stocks.

Until the mid-1990s, cash and deposits held by companies and households were around 1.1 times the size of Japan’s GDP. They have now grown to 1.7 times GDP, the highest among major economies.

The real problem is that the economy has been running below its potential for years, according to a paper published in July by a team of BOJ researchers. They identified the yawning “output gap” as a key factor behind Japan’s long-running, mild deflation.

Market and consumer psychology was one reason for the weak output and falling prices, the study concluded. Japanese companies and consumers had come to expect prices would fall and were behaving accordingly, the study noted. In fact, inflation expectations had been in retreat since 1990 and plunged in 2008. The BOJ researchers believe expectations of falling prices could become dangerously self-fulfilling.

Advocates of an ultra-easy monetary policy argue that cycle could be broken by pumping a river of money into the system -- economist Paul Krugman, a commentator Mr. Shirakawa is said to admire -- has urged the BOJ to do just that and “credibly commit to being irresponsible”.

Masayoshi Amamiya was a key figure in the Monetary Affairs Department group that is overhauling BOJ policy. He oversaw the division until May this year when he was sent to head the bank’s Osaka branch, a step expected to set him up for an eventual stint on the bank’s policy board.

A 57-year-old fan of the music of Bartok and Prokofiev, who jokes he feels more comfortable talking about classical scores than monetary policy, won praise for bringing a newfound flexibility to BOJ policy since the previous round of quantitative easing. Admirers inside the bank refer to “Amamiya magic” for his skill at handling communication with lawmakers, and coming up with creative banking ideas.

Mr. Amamiya was at the center of deliberations leading up to the BOJ’s surprise easing in February, when it announced an inflation target of 1 percent and raised its asset-buying target by ¥10-trillion ($122-billion). Mr. Amamiya also helped make the case for a follow-up easing in April on the belief that, when necessary, the central bank must aim for a “shock” effect.

The most recent appointments to the policy board -- former economists Takehiro Sato and Takahide Kiuchi -- are also more strongly committed to an easing policy. Both warned on October 30 that the central bank’s consumer price inflation forecasts were too optimistic. Their appointments came after the Diet turned down a nominee --- Ryutaro Kono, an economist at BNP Paribas -- because lawmakers thought he would not be aggressive enough. Rarely if ever has a government nominee for a board member been rejected in parliament.

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