Billions of Dollars the Bank of Japan is Adding to the Market

Why the Bank of Japan's Political Play Won't Work: The Ticker

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By William Pesek

Independent by design, central banks are supposed to be above politics. The idea is that while lawmakers pander and plot, monetary officials act out of the spotlight for the good of the economy.

That's probably the image the Bank of Japan wanted to project this week when it unexpectedly set an inflation goal and added $128 billion to its asset-purchase program. But the move won't work. The reason: The BOJ itself is playing politics.

The step is simply too timid to make a dent in the deflation with which Japan has grappled for more than a decade. For years, politicians, including a number of prime ministers, urged the central bank to set an inflation target to attempt the flipside of what Paul Volcker did in the U.S. in the late 1970s and early 1980s as Federal Reserve chairman.

The BOJ says it will target 1 percent inflation for the time being. Trouble is, BOJ Governor Masaaki Shirakawa must back up the move with ample monetary firepower. So far he hasn't, and traders are sure to shrug it off as a politically motivated effort to reduce pressure on the central bank. As such, Shirakawa's policy shift is unlikely even to slow Japan's trend toward deflation, never mind reverse it.

There are two big problems here. One is how Japanese politicians shirk their responsibilities onto the central bank. Yes, the BOJ could do more to revive the economy, but fiscal policy is important, too. As politicians mull raising taxes, they aren't considering pro-growth policies to boost the nation's growth rate. Even though Japan has the world's biggest public debt, it isn't getting much from its borrowing. Lawmakers must work to get more traction from fiscal policy.

Two, inflation targets work only if they have teeth. The chronic deflation undermining corporate Japan requires a much, much bigger infusion of liquidity than the BOJ unveiled this week. Japan's $5.5 trillion economy is the world's third-largest. Does the BOJ really think adding the annual output of New Zealand is going to make a difference? Any Economics 101 textbook will explain why markets are yawning.

(William Pesek is a Bloomberg View columnist. Follow him on Twitter.)

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-0- Feb/15/2012 23:39 GMT