With 2 percent inflation target, Japan signals new strategy to boost economy


Bank of Japan Governor Masaaki Shirakawa, center, and board members attend a policy meeting in Tokyo on Jan. 22. (Japan pool/AFP/Getty Images)
January 22, 2013

Japan’s central bank on Tuesday doubled its inflation target to 2 percent, a main pillar in the country’s aggressive new strategy to break away from a two-decade economic stagnation.

The Bank of Japan’s new commitment, coupled with the government’s splurge of spending on public works projects, represents a controversial rethink about the way developed countries should repair their crisis-battered economies.

Under Prime Minister Shinzo Abe, elected last month, Japan has turned away from the well-worn practices followed by economies under duress — conventions that call for austerity and debt reduction. Japan, instead, is trying to spend its way out of a recession rather than cutting back.

The goal is to shake the world’s third-largest economy from two of its most unrelenting problems, chronic deflation and a strong currency, which hurts Japan’s exporters by making their products more expensive overseas. But the strategy represents a particular gamble for a nation already with the highest debt burden in the developed world, at 220 percent of the gross domestic product.

If Japan’s public works spending does stimulate the economy, and if the central bank’s monetary easing weakens the yen, Japan could break from its prolonged slump. Investor confidence would rise, the gross domestic product would grow and the government would take in more tax revenue to cover its debts.

But some economic analysts, noting decades of mismanaged Japanese public spending, fear Abe’s stimulus will help little more than the enormous construction and business firms that support his conservative party.

“Spending money is not a bad thing, but [the government] needs a much clearer method of making sure that the money they spend is on high-return projects,” said Robert Feldman, Morgan Stanley’s chief economist for Japan. “No more bridges to nowhere.”

Skeptics also note that Japan’s government has no clear plans for deregulation or restructuring — long-term moves that could help the economy after stimulus spending runs out.

At a news conference last week in Washington, International Monetary Fund Managing Director Christine Lagarde said Japan’s fiscal and monetary package is not “particularly appropriate,” unless the country also shows a “determination to change the debt trajectory and reduce the deficit.”

Japan’s strategy has “caused a stir in international policy circles,” according to a note from Barclays Bank researchers, but the strategy is unlikely to spur copycats — even if it works. In Europe, central bankers are likely to stay conservative as a way to reestablish credibility in the euro. And in the United States, though aggressive monetary easing is already in place, there is little political appetite for a major government stimulus package.

The Bank of Japan decision Tuesday was controversial in its own right, because it was made under intense pressure from the central government. Since his election campaign, Abe has called on the central bank — equivalent to the Federal Reserve in the United States — to loosen monetary conditions and set a far more audacious inflation target.

By law, the central bank is independent from the Japanese government, but some economists say that Abe is trying to circumvent that. He has considerable leverage, too: In April, he’ll appoint the bank’s next governor, presumably one with policy preferences to match his own.

After its two-day meeting ended Tuesday, the central bank and the government released a joint statement in which both sides pledged to “strengthen their policy coordination.”

The bank’s new inflation target was widely anticipated. The bank said it would expand its asset purchasing program beginning in January 2014, when it will begin buying up government bonds and other forms of debt worth 13 trillion yen ($145 billion) monthly. This purchasing, the bank said, will go on for as long as necessary.

There are questions about whether Japan can hit its new inflation target. Under the current program, Japan has failed to hit its 1 percent goal. This attempt will use the same basic tools — interest rates at virtually zero, coupled with asset purchasing.

Still, Japan’s new fiscal and monetary policies have already prompted some short-term market gains. Since Abe rolled out his economic policies in mid-November, the yen has weakened 13.5 percent against the dollar, relieving some of the strain on Japanese export giants like Toyota and Sony. Meantime, the Nikkei stock index has soared above 10,500 for the first time in nearly two years, staging its most prolonged rally since 1987, according to Bloomberg.

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