The Swiss Just Made Japan's Job Harder
Haruhiko Kuroda's monetary "bazooka" just got outgunned by the Swiss. Since April 2013, Japan's central banker has been pumping trillions of dollars into the economy in an attempt to generate 2 percent inflation. But in a mature, aging economy like Japan's, the effort is 95 percent about confidence. In order to "drastically convert the deflationary mindset," as Kuroda puts it, the Bank of Japan must transform sentiment among households and businesses. Kuroda's massive bond purchases mean little if the Japanese don't trust that better days lay ahead.
The Swiss National Bank’s move to abandon the franc’s cap against the euro may have blown a hole in Kuroda's strategy. By reneging on a promise made time and time again that he wouldn't ditch the policy, SNB President Thomas Jordan "has undermined the credibility of central banks," says Simon Grose-Hodge of LGT Group in Singapore. Now, at central banks around the globe, he adds, "the unthinkable is entirely possible. You can't rule anything out."
Even if the BOJ issues another blast of quantitative-easing after its two-day policy meeting next week, the question is how effective the move would be. Kuroda's Oct. 31 shock-and-awe stimulus announcement worked for a time by bolstering perceptions that steady inflation was within reach. But this time, with even Economy Minister Akira Amari admitting "it will probably be difficult" for the BOJ to succeed, markets are likely to be more skeptical of the bank's staying power.
Even aside from the Swiss decision, Kuroda has had trouble with signaling -- what bankers call "open-mouth operations." Understanding how minutely markets scrutinize their every word and deed, officials in Washington and Frankfurt have learned to use that obsessive attention to their advantage. In an April 2013 study, Federal Reserve Bank of San Francisco economists Michael Bauer and Glenn Rudebusch found "signaling effects are larger in magnitude and statistical significance" than investors appreciate. Former Fed Chairman Ben Bernanke's skillful use of verbal winks, nods and innuendo to lead expectations helps explain why QE worked better in the U.S. than Japan.
Part of Kuroda's problem is simply his soft-spoken, professorial personality. Cleverer speech-writing might help. So might dropping market-moving hints in the media. The real challenge, though, is the credibility of the institution Kuroda runs. Before he took over in March 2013, predecessor Masaaki Shirakawa had spent five years pledging an end to deflation. Before Shirakawa, Toshihiko Fukui and Masaru Hayami also assured the world higher prices were on the way.
Because the supply side of Japan's economy is so rigid, Kuroda's ability to sway the demand side is limited. His job would be easier if the government were adding more fuel to the BOJ's efforts. The fact that it's not means "further BOJ actions may be treated with a good deal of skepticism on the part of the household," says Jonathan Cavenagh, a currency strategist at Westpac. "Structural reform is still the missing ingredient, but meaningful efforts on this front still seem some distance away." As much as Kuroda needs to find better ways to guide markets, he also needs to turn his open-mouth operations on Tokyo's bureaucracy.
Why not, for example, use the BOJ's honest-broker role to prod the government to offer tax cuts to companies that increase wages, in order to spur spending? As I've written before, the BOJ should champion the idea of taxing banks that hoard bonds and households with excessive savings. It could offer central-bank-backed debit cards that put money into consumers' pockets, rather than continuing to buy government securities. Kuroda could begin buying up distressed assets around the nation, including property in rural areas.
Getting people to borrow and banks to lend is a confidence game. Everyone must trust that the institutions promising to keep things safe and raise living standards can make good on those promises. That has posed a gargantuan challenge to Kuroda from the start. Swiss surprises or no, the task isn't getting any easier.
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