As University of Tokyo economist Takatoshi Ito has noted, Japan's current policy framework was shaped by the hyperinflation of 1974, when prices surged 30 percent and politicians overruled the central bank's recommendation for higher interest rates.
The situation is very different today; the price level has been falling for the last 15 years, the economy is in the middle of its third technical recession since 2008, and newly elected Prime Minister Shinzo Abe has a strong electoral mandate to deliver at least 2 percent inflation.
At its first post-election meeting, the BOJ added another 10 trillion yen to the central bank's asset-purchase and lending programme, taking the total to 101 trillion yen. It also promised to review its medium-to-long-term inflation goal in January, giving a hint that it might adopt a more aggressive target.
But the target isn't credible because there is no institutional arrangement for making the central bank responsible for keeping its promises. Under Japanese law, it has full autonomy over monetary control. In the fight against deflation, that's a liability. No matter how much money the BOJ prints, the market expects it to reverse the process at the first hint of inflation, as it did in 2006.
A better alternative would be for the BOJ to make a contractual pledge to deliver a level of inflation, ideally through an accord between the governor and the finance minister. At the same time, the BoJ should be given more freedom to intervene in the currency market - something it is legally prevented from doing, except as an agent of the government. To achieve its target, the central bank must be allowed to cheapen the yen.
Such reforms might raise concerns about the BOJ's independence. But provided the new system was transparent and had legal sanctity, those concerns would be misplaced. The BOJ might lose the ability to set its own targets. But it would have greater autonomy in deciding how to achieve them.
CONTEXT NEWS
- The Bank of Japan on Dec. 20 eased monetary policy by expanding its 91 trillion yen asset-purchase and lending programme by 10 trillion yen. The BOJ also said it will review its medium-to-long-term inflation objective at its next policy meeting.
- The central bank, under pressure from the incoming administration of Prime Minister Shinzo Abe, may consider adopting a 2 percent inflation target as early as January, Reuters reported on Dec. 18. Reuters: Bank of Japan to mull 2 percent inflation target as Abe turns up heat.