Caught in the crossfire from both sides in the battle over tax hikes, the Bank of Japan succumbed to political pressure in announcing its latest monetary easing measures.
The central bank decided on April 27 to inject a net 5 trillion yen ($62 billion) into funds available in the market for financial institutions to pump-prime the sluggish economy.
Business conditions have already started to pick up, lessening the need for additional easing.
But Prime Minister Yoshiko Noda and his administration appear desperate to accelerate the improvement of those conditions. That is because achieving a certain level of economic growth would pave the way for Noda’s plan to double the consumption tax rate incrementally to 10 percent by 2015, a proposal that now hangs by a thread.
The BOJ’s move came on the heels of a similar decision on Feb. 14 to raise the volume of the fund to purchase government bonds and other assets from financial institutions from 55 trillion yen to 65 trillion yen.
The successive easing measures have bloated the outstanding amounts of government bonds purchased, which is turning the BOJ into a de facto undertaker of government debt.
On the evening of April 27, BOJ Governor Masaaki Shirakawa visited the Prime Minister's Official Residence as an observer at a government panel meeting seeking a way out of Japan's deflationary trend.
Motohisa Furukawa, state minister for economic and fiscal policy, looked satisfied after he was briefed on the BOJ's additional easing measure decided earlier in the day.
"It was an appropriate measure," Furukawa said following the panel meeting.
More than a week earlier, a decision was made to hold the government panel meeting immediately after the BOJ's monetary policy meeting. And the central bank’s policy meeting was immediately preceded by a meeting of senior DPJ and BOJ members, indicating that an additional easing measure had been a foregone conclusion from early on.
Some DPJ lawmakers are even discussing potential amendments to the BOJ Law to give political leaders more power in deciding when to intervene in the markets. They also propose provisions that would allow the government to set inflation targets and dismiss the BOJ governor.
Behind the closing circles on the central bank lie the political struggles over Noda’s plan to double the consumption tax. The prime minister has said he would stake his political life on passing legislation to raise the tax rate.
But he faces fierce resistance from DPJ lawmakers opposed to the tax hikes, including political heavyweight Ichiro Ozawa, leader of the largest intraparty faction. The Tokyo District Court on April 26 found Ozawa not guilty of conspiring to falsify political fund reports, and his acquittal is expected to increase the clout of the tax-hike opponents.
To curb their influence, Noda is desperate to realize a business recovery with the help of the central bank and to create an economic climate that allows for an increase in the consumption tax rate.
The BOJ also came under pressure from the tax-hike opponents because many of them believe that if business conditions improve only through monetary easing measures, then there would be no need to raise taxes.
The dual speculations of tax hike proponents and opponents have driven up the political pressure on the central bank.
With the rift widening within the DPJ and the ruling party’s deadlock with the opposition parties, it has become more likely that a final settlement of the consumption tax hike issue will be put off.
In the meantime, only the BOJ is being forced to take action.
One government source expressed sympathy for the central bank.
"Whatever the BOJ may do, nothing will change drastically," the source said. "The BOJ is not really in a deadlock, but it is becoming desperate."
The April 27 decision said the central bank will buy 10 trillion yen more into long-term government bonds.
The BOJ has already purchased large amounts of government bonds from financial institutions. The latest easing measure will stretch those sums to 43 trillion yen annually, nearly matching the 44.2 trillion yen in bonds that the government plans to issue anew in fiscal 2012.
The central bank is essentially helping to bail out the debt-ridden government.
The Public Finance Law says the BOJ should not, in principle, undertake government bonds directly from the government. The central bank is not exactly violating that law because it is buying government bonds that are traded in the market.
However, the BOJ is "going beyond a limit," according to Izuru Kato, chief economist at Totan Research Co.
In 1932, Finance Minister Korekiyo Takahashi approved the BOJ undertaking government bonds to help Japan emerge from the Great Depression. But that was followed by an unstoppable expansion of military budgets.
Japan's defeat in World War II turned the government bonds into scraps of paper. The hyperinflation of early postwar years had a huge effect on the general public.
The BOJ has set a "banknote rule," which says the amount of government bonds purchased should not exceed the value of banknotes circulating in the market.
Shirakawa has reiterated that monetary easing is not intended to help cover deficits in state finances. However, the total sum of government bonds purchased is expected to exceed the outstanding value of banknotes by the end of this year.
The banknote rule is now only one step away from becoming a scrap of paper.
(This article was written by Yukako Ito and Yukio Hashimoto.)
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