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Why Japan's Monetary Policy Makes Good Sense

The commentary on Japan's monetary policy, "Printing yen is not the answer" (Finance, July 1), raises the specter of Weimar Republic-like hyperinflation but then acknowledges that Japan is still plagued by deflation. If so, it makes perfect sense to run an aggressively easy monetary policy.

Japan has fallen into a "liquidity trap" caused by weak credit demand and impaired intermediation by the banking sector because of massive bad loans. Normal monetary policy doesn't work, since liquidity injections do not lead to credit expansion by banks. Therefore the money multiplier is declining. Indeed, the sharp rise in base money growth in Japan that you cite has had no perceptible impact on loan growth so far. The only conventional alternative for monetary policy is to buy government bonds, which at least has the merit of pushing down bond yields somewhat. This may be "artificial," but isn't that what central banks are for?

You argue that this policy enables the government to continue on a "spending spree," but in fact this fiscal policy is probably too tight. Real public-works spending peaked in calendar year 1996 and has fallen every year since then except in 1999, while the most recent cut took place in 1998. The fiscal deficit remains large mainly because of falling tax revenues, caused by weak growth and an excessively progressive tax-rate system: Large percentages of individuals and corporations pay no taxes at all.

Monetization causes inflation only if the government spends the money, and this is not happening. Japan faces massive debt deflation by the private corporate sector, whose debt has fallen cumulatively by roughly 30% of gross domestic product over the past four years, as companies struggle to reduce the huge debt load built up during the bubble period. In this situation, the "fiscal discipline" that you recommend is exactly the wrong policy.

To be sure, growth of gross domestic product in the first quarter was strong, but this was mostly due to exports, as the strength of consumer spending was illusory and is likely to be revised away. Domestic demand is still weak. Since the economic recovery throughout the world is fragile so far, it would not be responsible or realistic to rely on export growth alone to generate a sustainable expansion. Moreover, the recent strengthening of the yen (which illustrates the limited impact of Bank of Japan policy) could undermine the positive impact of rising exports.

It is true that politicians have dragged their feet on structural reform, and economic recovery tends to blunt those impulses even further. Structural reform would no doubt enhance the effectiveness of monetary policy. There is no sign, however, that the adoption of bad macroeconomic policies would change this, and the resulting damage to Japan and other economies could be substantial.

Peter Morgan

Chief Economist

HSBC Securities (Japan) Ltd.


Your commentary criticizes Bank of Japan Governor Masaru Hayami for his aggressive monetary expansion. But after four years of deflation and three successive quarters of economic contraction, what else should he have done? Even if it does eventually lead to a surge in inflation, this would do more good than harm: Reducing the real value of nominal debts would stop good loans from going bad, and rising prices would discourage money hoarding. It is also unfair to blame Hayami for the government's poor spending choices. In fact, Hayami deployed the carrot-and-stick approach rather successfully last year, when he rewarded Prime Minister Koizumi's pro-reform budget with furthermonetary easing.

Many tasks remain for Japan--restructuring, writing off bad loans, improving transparency--but these will do little to increase demand in the near term. For the time being, printing yen is at least part of the answer.

Daniel Ryan


Eddystone, Pa.

Editor's note: The writer is an economist and Japan analyst. "Bono and O'Neill: Who's right on foreign aid?" (American News, June 17), a story about their recent trip to Africa, highlights the current debate on the effectiveness of foreign assistance. While there may be examples of projects that did not achieve desired results, on the whole, the record of poverty-reduction efforts is in fact quite impressive.

With the help of foreign aid, adult illiteracy in developing countries fell to 26% in 1998, down from 47% in 1970; life expectancy in poor countries has risen from 45 to 64 since 1960; there are 55 more democratically elected governments than there were in 1988; about 200 million people have moved above the poverty line since 1980; and smallpox has been eliminated. U.S. assistance through the U.S. Agency for International Development (USAID) has had a particularly significant impact. In Ethiopia, through a program implemented by the Academy for Educational Development (AED), primary-school enrollment has risen to 57%, up from 19% eight years ago.

In Madagascar, where 10% of infants were dying before their first birthday, primarily because of improper breast-feeding, a program funded by USAID and implemented by AED helped increase exclusive breast-feeding practices from 45% to 83% in less than two years. Community-based efforts and a national campaign led by the country's most popular singer helped convince mothers and, perhaps most importantly, the grandmothers, that breast-feeding could save their babies' lives.

In my book, such bottom-line results should make any CEO proud.

Stephen F. Moseley

President and CEO



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