Japan's Courageous Central Banker
By Brian Bremner
Well, it's official: Japan's economy is once again below the water line. The worse-than-expected 0.8% annual decline in first-quarter gross domestic product announced on June 11 likely will be a followed by yet another quarterly contraction -- meeting the classic shorthand definition of recession. And with the next Bank of Japan (BOJ) policy board meeting set for June 14, you can already hear the clamor for the central bank to do something -- anything -- to turn things around.
Maybe because of Alan Greenspan, who happened to be chairman of the Federal Reserve during the longest U.S. economic expansion, the markets now tend to attribute supernatural powers to central bankers. So BOJ Governor Masaru Hayami has been vilified for not reaching into his grab bag of monetary tricks to save Japan. In fact, his critics have charged him with gross negligence for suggesting that what Japan needs is some tough economic medicine, rather than a quick-fix monetary gambit.
For that courageous act, he should be receiving accolades, not brickbats. So the question is: Are Hayami and his policy-board colleagues (who aren't elected officials) violating some sacred covenant that says central bankers shouldn't talk about structural reform, especially when it involves tough choices best left to the political pros? The Economist, Princeton University economist Paul Krugman, and others have argued just that.
If that's the case, the BOJ's real job is to pull out whatever weapons it can to reflate the economy. By that single measure, it has failed miserably. Sure, nominal interest rates are at zero. But, hey guys, wake up. If you adjust interest rates that factor in a deflation rate of 2% or so, in real terms, the price of money is far too high for an economy as weak and highly indebted as Japan's.
Think about this for a minute. It's true that the BOJ's mission is to work toward price stability, with the long-range goal of promoting sustained economic growth. And there's nothing in the central bank's charter about issuing a clarion call for structural reform. But you really can't have price stability if government policies promote profligate government spending, fail to address a dysfunctional banking system, or result in handouts to overcrowded, inefficient, and highly indebted construction and retail industries.
That's pretty much the situation in Japan. And putting aside for the moment whether the BOJ itself has made the situation worse, all these factors feed into the collapse of price stability and the deflation that bedevil Japan.
So when Hayami and his team give speeches on the need for serious reform, they're talking very much about price stability. In fact, before reformist Prime Minister Junichiro Koizumi took power, Hayami & Co. were about the only voices out there talking about it at all. And that's precisely why central banks need to be independent of political meddling. Had the BOJ not won its independence in 1998, it probably would have been silent too.
As Morgan Stanley economist Robert A. Feldman points out, politicians think in terms of election cycles and view monetary policy as a short-term tool to get them through the next one. "Monetary matters are best taken away from legislatures -- even though the goals, constraints, and framework for conducting monetary policy are set by the legislature," he wrote in a recent analysis posted on the investment bank's Web site.
Even if critics doubt the legitimacy of the BOJ weighing in on structural reform, it still has the responsibility for pulling Japan out of its price slide, which is slamming profits and household incomes and costing jobs. The detractors argue that the BOJ ought to ramp up the money supply, underwrite Japanese government bonds, and maybe even buy up stocks, real estate, and sushi chains to pull the country out of the mire. Instead, it has done diddly-squat.
I'm not sure such criticism is deserved, since I've long been skeptical such stimulative monetary policy gambits would really work in this situation. The idea is that if you generate inflation of 2% to 3%, Japanese will start spending to lock in today's price on a Toyota before it costs more next year. Pumping a lot of cash into the money markets would get banks lending again, the theory goes. And inflation, of course, is great for debtors, who would see their debt loads melt away as the economy reflates.
My doubts are based on the fact that Japan's problems are too multifaceted for this treatment to be effective. Whether there's inflation or deflation, consumers aren't spending because they see no signs of a real recovery. The rational thing to do when you're anxious is to save, not spend. The banking system doesn't need more cash -- bankers are loath to lend when so much of Corporate Japan is ailing. Companies might get a lift from a bout of inflation, but the core problem is excess labor and capacity. Corporate profitability won't improve until those excesses are taken care off. That means painful structural reform.
Also, it's not as if the BOJ has done nothing. That's clear from a new research paper by Masaaki Shirakawa, adviser to the BOJ's governor, at the central bank's Web site. Shirakawa estimates that Japan took an $8 trillion hit to its wealth from the combined collapse of stock and real estate prices during the 1990s.
In response, the BOJ guided interest rates down to near-zero levels by February, 1999, and -- save for a brief and ill-timed hiatus in 2000 that took a key short-term rate up a quarter point last August -- has kept them there since March. Shirakawa also points out that bank lending contracted, not increased, while Japan's monetary base expanded a brisk 7% to 8% from 1998 to 2000.
In fact, a big chunk of the excess cash that went into the banking system was reinvested in the Japanese bond market. Now, plenty of market watchers are worried about a bond-market bubble, which like the stock and land speculative runs in the 1980s, could end in tears (see BW, 6/11/01, "Japan's Perilous Bet on Bonds").
FEEL THE PAIN.
As for buying more Japanese government bonds, which the reflation camp can't get enough of, it seems, the BOJ already has been quite busy. The central bank holds about 11% of Japanese bonds outstanding. As for buying up corporate bonds, stocks, and all manner of other investments, that kind of brings us back to the question of the proper role for a central bank.
On the one hand, critics lash out at the BOJ for saying sensible things about overhauling the Japanese economy. On the other hand, they see no problem with the idea of the BOJ launching an effective nationalization of the equity and the corporate bond markets -- or even becoming a monster real estate developer. Last time I checked, that was called socialism, not capitalism.
Truth is, Japan is caught in a liquidity trap, where traditional monetary policies lose their punch. Should Prime Minister Junichiro Koizumi survive an electoral challenge this summer and push his tough-love measures through, the BOJ surely will do everything it can to prevent a collapse of the banking system and the economy at large.
But it's still going to hurt -- a lot. Just like it did in the U.S., when Fed Chairman Paul Volcker's campaign against inflation slammed the American economy in the '70s. And there's little the BOJ can do or responsibly should do to prevent the pain that must be endured to help the economy. Hayami may have his faults, but saying what needs to be said shouldn't justify his public lynching. It is, very simply, his job.
Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BW Online
Edited by Beth Belton