Japan's Hopeless Inflation Target

After five years of unprecedented stimulus, the BOJ should recognize reality.

Still dreaming.

Photographer: Akio Kon/Bloomberg

If only all our public servants were as devoted as Haruhiko Kuroda. The Bank of Japan governor remains committed to reaching his inflation-rate target of 2 percent, even though five years of unprecedented monetary stimulus haven't gotten him close. Kuroda, undeterred, recently told Japan's parliament that he now thinks he can attain his perennially elusive goal by 2019, and only then will the central bank consider an exit from its unorthodox policies.

Kuroda deserves kudos for sheer perseverance. But it's high time that he give up on this dream. Not only will he never reach his target -- he doesn't need to.

No matter how fiercely Kuroda holds course, evidence is mounting that pushing the inflation rate up to 2 percent is a near-impossibility. The Bank of Japan's assets have more than tripled over the past five years as it bought bonds on a huge scale in the hopes of suppressing long-term interest rates and boosting prices. The economy, running hot in recent quarters, has been facing serious constraints on capacity and labor.

Yet prices haven't much budged. Although headline consumer prices rose 1.4 percent in January, the highest rate in more than three years, the BOJ's favored measure of underlying inflation, which strips out volatile energy and fresh food prices, edged up a mere 0.4 percent.

Last month, economists at research firm Capital Economics characterized the chances of lifting the inflation rate to 2 percent over the long term as "slim." They argued that Japan's current capacity shortages aren't nearly sufficient to boost prices to that rate, and the central bank’s stimulus has failed to raise expectations among corporations and households for significant future inflation.

Even Kuroda admitted in his recent testimony that wages would have to grow at 3 percent for inflation to hit his target -- and he's not close there, either. In January, workers' total cash earnings, which include bonuses, inched up a mere 0.7 percent, while base wages rose a pathetic 0.2 percent, even though the unemployment rate is only 2.4 percent.

For all that, though, Japan is currently enjoying its longest stretch of growth since the 1980s -- even with the inflation rate far below Kuroda's target. That raises two possibilities.

One is that Japan's economic woes have been widely misdiagnosed. Many economists have argued that Japan's core problem is deflation, and that only by breaking deflationary expectations could the BOJ convince companies and consumers to invest and spend, thereby jump-starting a new cycle of growth. But growth has increased nicely even without a significant change in inflation expectations. That suggests the roots of Japan's long malaise lay elsewhere -- in excessive regulation, a dearth of entrepreneurship, poor corporate governance, a broken labor market, and an aging population.

The other possibility is that Kuroda has already succeeded. Perhaps his stimulus efforts have boosted the inflation rate enough to support stronger economic performance even if it never reached 2 percent. That suggests the BOJ's recent decision to modestly taper its bond-buying program is the right course of action.

In fact, the economy may be better off because Kuroda missed his target. Japan's high number of retirees could be seriously hurt by too much inflation. And with government debt at 240 percent of gross domestic product -- more than twice the level in the U.S. -- a higher inflation rate would also mean higher interest payments. Debt service already eats up a quarter of the budget even with rates artificially depressed.

With Japan's economy now showing some signs of slowing, Kuroda will likely feel pressure to keep his cash-injecting policies in place, even as the possibility of reaching the 2 percent target remains distant. Nevertheless, he should sleep easy. He may not fulfill his dream, but, in the real world, he's done all he can.

(Corrects reference to interest payments in 10th paragraph.)
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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