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The Bank of Japan still has “some distance to cover” before it can sustainably meet its 2 per cent inflation target, its governor, Kazuo Ueda, has told the Financial Times Global Boardroom. This is a vital objective. The central bank’s slow and cautious approach to normalising its ultra-easy monetary policy therefore makes a great deal of sense. What makes less sense, however — except as a matter of electoral politics — are plans by Japan’s government for a fiscal stimulus, much of it timed to arrive in the middle of next year. Fumio Kishida, the prime minister, should think again.
In the latest tweak to its monetary policy, which the BoJ announced at its meeting last month, the central bank changed its 1 per cent limit on 10-year government bond yields from a strict cap into a “reference” around which it will “nimbly conduct” the buying of assets.
The move gets zero marks for comprehensibility — but the strategy behind it is solid enough. Ueda is trying to keep policy as easy as he can while allowing some adjustment to market pressures, fuelled by the gap between negative interest rates in Japan and 5 per cent interest rates elsewhere, that have forced the yen below ¥150 against the dollar.
Even though Japan’s headline inflation rate has been above 2 per cent for many months, there are several reasons why Ueda is correct to delay a substantive tightening of policy. First, as he notes, much of the pressure on Japanese prices is imported, with domestic wages still not rising fast enough to meet the inflation target over the long term.
Second, global interest rates are likely to turn at some point, with Ueda highlighting doubts about the outlook in China and the US. There is a window in which to embed inflation in Japan, but it may not last for long. Third, while above-target inflation can be tackled by raising interest rates, Japan has little scope to cut rates if prices undershoot. It therefore makes sense to err on the side of higher inflation.
By contrast, the Kishida government’s fiscal policy is harder to understand. Last week it announced a stimulus that could, in theory, run to 3 per cent of gross domestic product. Headline numbers usually overstate the real value of a Japanese stimulus.
The package includes quite large tax cuts and rebates for households — although they only last for a year, so their impact on consumption is questionable — as well as some sensible corporate tax changes designed to encourage investment. Overall, economists do not expect a large effect on growth. The package has the strong flavour of an unpopular government trying to curry favour with a grumpy electorate.
At many moments during the past 30 years, Japan needed fiscal stimulus to tackle slack in its economy and the risk of deflation. One purpose of such stimulus was always to get the economy into a healthier equilibrium, with positive inflation, so the business cycle could be managed by changing interest rates, and the budget deficit kept under control. It remains important to avoid a premature tightening of policy. It is perverse, however, to ease fiscal policy just as the central bank is finally moving in the other direction.
Doing so risks making the Bank of Japan’s exit from easy policy, which Ueda already describes as a “serious challenge”, even harder. It also uses up scarce fiscal space that will be needed in the case of a global economic shock.
Repeatedly during the past three decades, the Bank of Japan has been knocked off course by badly timed tax rises. It would be more than unfortunate if the next mistake went in the other direction.
