Battling deflation in Japan

Feeling deflated

Dec 1st 2009 | TOKYO
From Economist.com

Japan’s central bank takes an overdue swipe at an old foe

THE Bank of Japan (BoJ) must feel as if it has a bad case of déjà vu. Three years after the central bank thought it had ended deflation, it has returned. And to fight it, the bank has had to resurrect a policy tool it tried to bury long ago—quantitative easing. If that is not bad enough, the BoJ once again has to deal with a government breathing hotly down its neck.

The BoJ’s discomfort explains why, on Tuesday December 1st, it made what analysts considered to be a half-hearted attempt to reflate the Japanese economy and weaken the yen. What the bank did was better than nothing, but it did not go as far as some had hoped—nor as far as Japan needs.

On the face of it, the BoJ’s announcement that it would make available ¥10 trillion ($115 billion) in three-month loans fixed at a 0.1% interest rate, appears generous. The loans can be exchanged for a broad array of collateral such as Japanese government bonds, corporate bonds, commercial paper and other assets. They are aimed at boosting the economic recovery by providing liquidity to banks.

The size of the facility amounts to only 2% of GDP, however, which analysts believe is neither enough to ease the deflationary threat in Japan significantly, nor to weaken the yen seriously. Masaaki Shirakawa, the governor of the BoJ, deliberately avoided discussing the currency at a news conference after the meeting, which frustrated those who think the financial authorities need to speaking plainly about the dangers of deflation to jolt Japan out of years of economic stagnation. “It was the size and the commentary that were disappointing,” said Richard Jerram, chief economist of Macquarie Securities in Japan. “It was all pretty tame.”

Added to which, Mr Shirakawa described the measures as “quantitative easing in broad terms”. But this appeared to be more of a sop to government ministers who have called for such a policy, than the result of a firm conviction on his part. Mr Shirakawa is among those in the BoJ who have been sceptical of the merits of quantitative easing, which it used during the deflationary years between 2001 and 2006. The BoJ has been cautious about using it ever since. According to GaveKal, a financial consultancy, during the global financial crisis Japan’s monetary base increased by a paltry 4.7% a year; in America, it has grown by 71%.

Analysts said the BoJ’s move would have had more impact if it were accompanied by dramatic policy initiatives from the government that looked like a serious attempt to weaken the yen. But that did not happen.

Instead, after a cabinet meeting on Tuesday, the fledgling administration of Yukio Hatoyama, the prime minister, lamented the strength of the yen and drew up some ill-defined counter-measures. These included the unveiling of a supplementary budget by the end of the week to tide Japan over for the rest of the fiscal year ending in March. But the size was not expected to be much bigger than the ¥2.7 trillion shaved off a previous budget by the new government. Its intention to find ways to increase domestic demand was similarly vague.

Mr Hatoyama, who indirectly put pressure on the BoJ by announcing on Monday that he planned to meet with Mr Shirakawa, praised the bank after Tuesday’s announcement. “It has demonstrated through its actions its determination to stem deflation and revive the economy,” he said. His meeting with Mr Shirakawa was still expected to go ahead.

Whether or not his government eases up on the central bank may well depend on what happens to Japan’s financial markets. The yen was lower against the dollar and other currencies during and after the central-bank meeting. The stockmarket also benefited from hopes that the yen would fall, because of the damaging effect the currency is having on exporters.

The yen may well climb higher again if the markets feel Tuesday’s efforts were not meaningful enough. However, now that the BoJ and the government have put the markets on notice that they are vigilant to the deflationary risk posed by a rising yen, they may be more inclined to use concerted action next time.