Japan is making a drastic shift in monetary policy in its latest attempt to spur inflation and get the world's third-largest economy out of a long, debilitating slump.
Bowing to demands from Prime Minister Shinzo Abe, the Bank of Japan announced April 4 that it would reconfigure its policies to double the money supply, or the amount of funds in circulation, and achieve a 2 percent inflation target at the “earliest possible time.”
The central bank has launched “a new phase of monetary easing both in terms of quantity and quality” that it said would “drastically change the expectations of markets and economic entities.”
Financial markets reacted with relief. The Japanese yen, which was trading at about 92.8 yen per U.S. dollar, dropped to about 94.95 yen per dollar by mid-afternoon on April 4 after the announcement. The benchmark Nikkei 225 stock index rebounded from negative territory to close 2.2 percent higher.
New BOJ Gov. Haruhiko Kuroda has vowed to meet the inflation target within two years, heeding demands from Prime Minister Shinzo Abe to once and for all end a long spell of deflation that has hindered investment and economic growth.
Abe's government, which took power late last year, accused the previous central bank governor, Masaaki Shirakawa, of balking at undertaking bold enough monetary easing to get the economy back on track. The steps announced on April 4 under the first policy meeting chaired by Kuroda were in line with, or perhaps a bit bolder, than had been expected.
“The first step is to get out of deflation and get a much higher nominal growth rate,” Kozo Yamamoto, a senior lawmaker in Abe's Liberal Democratic Party, said in April 3. A doubling of the money supply was needed to achieve that aim, he said.
The policies announced on April 4 are a fundamental shift in how the BOJ conducts monetary policy and appear a major concession to government demands, despite the bank's ostensible autonomy.
To further boost the economy, the government has increased public spending to help perk up demand, and has promised reforms to help make the economy more competitive in the long-run.
Whether these strategies can work will hinge on expectations of future inflation prompting consumers and companies to begin spending more money sooner to avoid rising prices, as Abe and his backers contend.
The past 15 years of deflationary stagnation, they say, is largely due to the tendency of consumers to hold back, waiting for prices to fall further. Expectations of weak demand, especially given Japan's shrinking and aging population, discouraged corporate hiring and investment, pulling prices still lower.
Critics of so-called “Abenomics” say that without wage increases to match the price hikes, frugal consumers may be even less willing to spend.
In any case, the BOJ has delivered on Kuroda's promises for bolder action.
Instead of carrying out money market operations to target an interest rate level, the central bank will focus on increasing the monetary base, or total amount of cash in circulation and funds of commercial banks held by the central bank, by about 60 trillion yen to 70 trillion yen ($637 billion to $744 billion) a year.
The idea is that increasing the amount of cash in circulation will help push prices higher.
At the same time the BOJ plans to increase purchases of Japanese government bonds to total 50 trillion yen a year to encourage interest rates to decline, which it hopes will facilitate more lending. It will continue to buy commercial paper and corporate bonds up to levels of 2.2 trillion yen and 3.2 trillion yen respectively, and maintain that level.
The central bank is also extending the average remaining maturity of the bonds it purchases from slightly less than three years to an average of seven years by making bonds with all maturities, up to 40 years, eligible for purchase.
As expected, the bank also extended the range of assets it can purchase, to include more risky real estate investment trusts and exchange-traded funds.
As part of the new strategy, the BOJ will end its current asset-purchasing program, absorbing it into the future purchases of bonds, it said.
Answering concerns that the stimulus program would further raise Japan's public debt, the statement said that the government bond purchases would be “executed for the purpose of conducting monetary policy and not for the purpose of financing fiscal deficits.”
The BOJ will “examine both upside and downside risks to economic activity and prices and make adjustments as appropriate,” it said.
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