The Politics of Japan's New Monetary Stimulus

6 MINS READApr 8, 2013 | 10:30 GMT
Bank of Japan officials at a meeting in Tokyo on April 4

The new governor of the Bank of Japan won almost unanimous consent for his proposal to launch massive monetary stimulus in Japan. The anticipation of the new policy has already contributed to a sharp drop in the yen's value relative to export competitors. This move will not revive the whole economy, but the combination of political consensus and the government's willingness to embrace new ideas is a notable development. 

Under its new governor, Haruhiko Kuroda, the Bank of Japan's policy board approved a plan to transform Japanese monetary policy during its April 3-4 meeting. The goal of the plan is to launch massive monetary stimulus on the order of the U.S. Federal Reserve's stimulus — namely, to double the monetary base, unify and expand all bond-buying schemes and aim for an inflation rate of 2 percent in two years. These policies mark a significant departure from the Bank of Japan's reputation of having practiced monetary restraint relative to the developed world's other major central banks since the global financial crisis began. The Financial Times pointed out that the bank's monthly bond-buying will rise to about 1 percent of Japan's gross domestic product, whereas the U.S. Federal Reserve buys about 0.5 percent of the U.S. gross domestic product.

The Bank of Japan's announcement has been expected since the Liberal Democratic Party, Japan's dominant party, and its coalition partners won a two-thirds majority in the House of Representatives in the December 2012 elections. The party wants to assure voters that it will fulfill its promises of total economic rejuvenation so that this decade will not become Japan's third consecutive "lost decade" after the bubble burst of the early 1990s. The Liberal Democrats hope to regain a majority in the upper house of parliament in July and thus control both houses. Looking further ahead, they hope to forestall the fragmentation that eroded their domination of Japanese politics during the lost decades and gave rise not only to the Democratic Party's rule from 2009-2012, but also to a more nationalist challenger, the Japan Restoration Party.

The Bank of Japan's proposal mainly consists of a plan to engage in aggressive quantitative easing, or aggressively printing money and buying bonds in order to ease debt pressures in the financial system. The bank will double the monetary base and the average maturity of the Japanese government bonds that it purchases, buy a range of riskier assets (like exchange-traded funds and real estate investment trusts) and try to achieve an inflation rate of 2 percent year-on-year within two years. The central bank's purchase of more bonds will drive down long-term rates, easing financing pressures on banks and, ideally, on the firms and households that borrow from them.

Monetary stimulus is only the first part of the Liberal Democratic Party's economic revitalization. Japanese Prime Minister Shinzo Abe is also planning fiscal stimulus, the specifics of which will emerge later this year, and a range of structural reforms, including breaking up the power sector and freeing up trade policies. But the monetary component of this sweeping reform is particularly important, because while Japan has launched numerous stimulus packages in recent decades (at least four since the global financial crisis began), its central bank's previous leaders kept it far behind the Fed, the Bank of England and the European Central Bank in monetary policy easing.

Nevertheless, fanfare over Abe's plans should be tempered. Deflation is the deeply entrenched scourge of the Japanese economy, and it has roots in factors like demographic decline, industrial overcapacity and weak external demand that printing money cannot help. Takahide Kiuchi — the lone dissenter in the Bank of Japan's plan to achieve 2 percent inflation in two years — has noted that the bank should first achieve 1 percent inflation before hazarding its credibility on a higher target. Fiscal stimulus, though it may lift growth in 2013-2014, has trickled into the system for years, never with lasting effect. And the Liberal Democrats are waiting until after elections to specify structural reforms, such as breaking up the power sector or liberalizing external trade, which may well prove unachievable given the strength and interests of the influential industries involved (the agricultural sector, for instance, remains untouchable).

Ultimately, Japan's ability to curb deflation will be dependent upon whether it can change consumer expectations. As Abe pointed out in an April 2 parliamentary debate, the Japanese consumer must become accustomed to generally rising prices in order to buy sooner, rather than save in anticipation of falling prices, as has been the norm. The combination of monetary and fiscal stimulus may help to do this for a time. But high energy prices could become a problem, and will continue at least until Japan restarts the nuclear energy plants that were shut down after the country's 2011 earthquake. Moreover, the government's plan to boost wages so far consists only of talk as it exhorts companies to lift wages or give employees more security.

Japanese Yen Drop

Japanese Yen Drop

Naturally, the Liberal Democratic Party projects an economic rejuvenation to build on political capital from its election and to try to win the upper house of parliament. There is, however, one tangible way in which its plans and the central bank's policy-easing have already yielded results. The value of the yen has dropped 12 percent against the U.S. dollar since January, helping to erode the currency advantages of Japan's closest competitors. On a trade-weighted basis, the yen has already taken a significant dive in value relative to the Chinese yuan and the South Korean won. Herein lies the immediate importance of the Bank of Japan's policy: A weaker yen makes Japanese exports more attractive to the U.S. market, and export growth remains Japan's best chance at raising growth rates (net exports often account for 10-20 percent of yearly growth). Energy prices will encourage the central bank to limit the yen's fall, but Japan's leadership has apparently decided it is willing to become more competitive with its neighbors on the level of currency in order to appease industrial and political dissatisfaction with the weak economy at home.

Rising international competitiveness points to a shift taking place beyond the realm of economics. Aggressive quantitative easing marks a change from previous central bank policies, suggesting that political pressure in favor of growth in the sluggish economy has finally forced an adjustment in the priorities of the traditionally inflation-averse central bank. Japan is a major world power that hit a low point in 2011. Rediscovering a sense of national purpose will not happen merely as a result of the Liberal Democrats regaining power, but the government's willingness to experiment with new ideas is a necessary step in the process of national deliberation that will make that rediscovery possible.

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