The Bank of Japan: Clutching at Straws?

Abandoning interest rates and focusing on money supply is a radical step for any central bank. For the Bank of Japan, it's also an act of desperation. This is the BOJ's third major try at trying to fix the Japanese economy--and with each pass, things only get worse. For a long time, the bank ran a policy of keeping interest rates close to zero, in hopes that easy money would encourage Japan's private banks to sell of some their billions of dollars in bad debts. Then last August, BOJ head Masaru Hayami decided to raise interest rates a tad above zero to make the debt more expensive to hold, and thus get Tokyo's bankers to sell it off. Recently, Hayami reversed course once again and let interest rates go--while targeting bank reserves to pump more money into the financial system. This sweetener of generous credit is supposed to get banks to sell off the debt.

Unfortunately, Japan's banks aren't likely to purge their debts until a regulator orders them to do so. Yet every time a regulator tries, Tokyo soon finds other employment for him. Hayami's plan to offer easy money in return for good behavior looks like a nonstarter. It can work only if serious inflation is generated, raising the value of the real estate behind bank debt, making loan sales more attractive.

The central bank says it's not bent on reflating the economy, but only on arresting a scary decline in asset prices, the same kind that worries the Fed in America. For now, that may be enough to hope for. But until the banks clear the sludge out of the financial system, Japan will remain the world's biggest no-growth economy.

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