The Reformist Premier Needs a Reformist Central Banker
By Brian Bremner
Japan's new Prime Minister, Junichiro Koizumi, has grabbed the world by the lapels with his reformist platform and provocative Cabinet picks, including no less than four women. But when it comes to the future of the Japanese economy, his most critical call yet may be tapping the Bank of Japan's next leader.
Tokyo was recently rocked by rumors that BOJ Governor Masaru Hayami is ready to call it quits, though his current term runs until 2003. During a meeting of the world's money lords and central bankers in Washington, Hayami shot down press reports that he was heading off to the golf links. Well, sort of -- he allowed that he would soldier on as long as his health permits.
Given his age, 76, and the fact that he has one of the most thankless tasks in central banking -- fixing a deflationary and debt-ridden Japan -- he may well be signaling that it's time for him to go. If that happens, the newly minted Premier, on top of consolidating an uncertain power base within the Liberal Democratic Party, would be facing a very tough decision. A wrong one would imperil the credibility of the BOJ, which won its formal independence from government meddling under a new bank charter just three years ago.
To understand why Koizumi's choice is so crucial, a little history is in order. Through most of the post-war era, Japan's monetary policy was in effect subsumed under the needs of the state. And it sometimes yielded to political pressure at critical points. The result hasn't been pretty. Part of the problem was that the central bank's Policy Board, which calls the shots on interest rates and money supply, long had no power when it really counted. The influence of the Finance Ministry was just too prevalent. The Ministry effectively handpicked board members. The BOJ governor post, by tradition, rotated between senior Finance Ministry officials and those of the central bank. The odds of a renegade Policy Board objecting to government policy were next to nil.
That created a moral hazard that resulted in some wayward monetary policy calls. In 1972, against the advice of the BOJ, Prime Minister Tanaka Kakuei ordered the central bank to lower interest rates to fund his regional development policies, dubbed Nihon Retto Kaizo Ron or Transforming the Japanese Archipelago. Loose monetary policy, coupled with the oil price shock of 1973, sent inflation soaring to a peak of 30% by 1974.
The 1990s touched off a trend toward ever bigger public-works spending as a source of economic growth. Today, Japan's massive budget deficit, clocking in at 10% of gross domestic product, is the direct result of more than $1 trillion worth of spending packages focused on public works designed to lift the Japanese economy out of stagnation. Such spending now consumes 20% of the Japanese budget, or more than twice the levels on a relative basis in the U.S., Germany, and France.
One cannot fully blame the BOJ. The Finance Ministry sets budget priorities, and the ruling Liberal Democratic Party has long relied on construction companies' financial contributions and voters in the rural areas that get the lion's share of the public-works largesse. Yet the question lingers: Had the central bank not subverted its monetary policy to the needs of the political world, might have things turned out differently?
Then, there were the screwups during the bubble era. From 1985 to 1990, Japanese stock prices jumped three-fold in value and land prices by roughly 400%. Though it saw clear signs of trouble at home, the BOJ didn't make any preemptive moves to raise rates, deflate the bubble, and engineer a soft landing. Why? It was under enormous pressure from both the Japanese and U.S. governments more interested in managing the yen-dollar relationship then worrying about a catastrophic buildup in stock and real estate prices in Japan. Too bad. The result has been years of stagnation for the world's second-biggest economy. That brings us back to 2001 and Koizumi. The BOJ's big challenge is providing the right kind of monetary stimulus to halt the country's deflationary slide in consumer and wholesale prices. That's tough given that interest rates are now hovering at near-zero levels, consumers aren't spending, banks aren't lending, and companies aren't investing.
Some want the BOJ to throw caution to the wind, turn on the printing presses, radically expand the monetary supply, and create inflationary expectations in Japan. Much to the chagrin of the government, Hayami has argued that ultraloose monetary policy will only put off Japan's central problems -- burning off excess debt, labor, and capacity -- for another day. Inflation is a wealth transfer from savers to debtors -- that is, from consumers to companies and banks.
When the economy looked stable last August, Hayami decided to lift Japan's zero interest rate policy by nudging short-term lending rates all of 25 basis points higher. But the U.S. economic slowdown late last year hit Japanese exports hard, and he reversed course in March. The Japanese Establishment turned on Hayami. You can fault him for his timing (if he goes, this will be the key reason), but his reformist agenda still makes a lot of sense and has some traction with the public. Hence, the surprise triumph of Koizumi in last week's LDP leadership race.
SEEKING AN INDEPENDENT.
Hayami has long argued that structural reforms, however painful, need to take place. If the government gets serious, the BOJ would expand the monetary supply appropriately and take other measures to make sure that the painful transition doesn't lead to an outright collapse of the economy. In a nutshell, Hayami offered to make a deal with a serious reform government. So what happens if Hayami leaves? Koizumi claims to be a reformer. If so, he ought to appoint someone who won't bend to political whims. Hayami's successor must have a long-range vision for the economy and the market savvy and flexibility to get there. Some prominent names are being thrown about. They include former BOJ bigwig Toshihiko Fukui, ex-Finance Minister and international diplomat Toyoo Gyohten, and Eisuke Sakakibara, a.k.a. Mr. Yen, who also hailed from the Finance Ministry.
It will take a real ace at the BOJ to help Koizumi pull of a recovery. And it will take some real guts to make sure the central bank doesn't once again become a plaything of the politicians. Should Hayami go, Koizumi should give careful consideration to Japan's next central banker. The stakes couldn't be higher.
Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BW Online
Edited by Douglas Harbrecht