A POLICY SHIFT FOR THE AILING ECONOMY

In mid-March the Bank of Japan made a major shift in its monetary policy. Since the start of the year it had made a series of moves on the interest-rate front, including two cuts in the official discount rate and the introduction of a Lombard-type lending facility, but its policy continued to be the target of much criticism. The article below by Iwata Kikuo, dated March 13, is representative of the voices that were being raised against the central bank; he and other critics were saying that the bank should reinstitute its former zero-interest-rate policy, pursue greater quantitative relaxation, move actively to buy up government bonds, and aim to achieve a positive inflation rate.

At the March 19 meeting of its Policy Board, the BOJ adopted a set of policies aimed at responding to these demands. The bank declared that it would increase its outright purchases of long-term government bonds up to a maximum corresponding to the volume of banknotes outstanding and that it would purchase about ¥1 trillion of bonds from financial institutions through money market operations, the target being to raise the total of their current account balances with the BOJ to around ¥5 trillion. The higher balances in these accounts, which do not pay any interest, are expected to encourage financial institutions to increase their lending. Furthermore, the BOJ announced that it would maintain this set of policies until the year-on-year rate of increase in the consumer price index reached zero or above.

The adoption of this sort of quantitative monetary easing was a momentous shift for the BOJ. The problem is whether it will achieve the intended effects. BOJ Governor Hayami Masaru himself has said that quantitative easing will not be effective unless the private sector takes the lead in getting the economy moving. Banks and other financial institutions are still laboring under mountains of nonperforming loans, making it questionable whether they will actually increase their lending. But it is still of great significance that the central bank has shifted from interest-rate targeting to quantitative targeting. The deflationary environment had been making it difficult to forecast future price movements. And interest-rate targeting had seemingly reached the limits of its effectiveness. Critics had been raising these points for quite a while before the BOJ made its switch. Some suggest that the central bank waited too long. Be that as it may, a problem that remains is that there is no guarantee that this quantitative easing will be followed by the needed structural reforms. Now that the BOJ has made this major shift, the ball is in the government’s court. The administration needs to make it clear that it will promote the structural reform process so as to create the conditions under which the new monetary policies will produce the desired results in the real economy.

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According to the results of the BOJ’s March tankan survey, released on April 2, the index of short-term business sentiment declined for the first time in 27 months, with the number of businesses taking a negative view of the prospects outnumbering those with a positive view. The downturn was especially pronounced among large companies in the manufacturing sector—and most particularly in the electric machinery industry, which has been affected by slumping exports. The locomotive of the recovery lost much of its steam. And the outlook on the nonmanufacturing side stayed negative. Also, small and medium-sized enterprises in both manufacturing and nonmanufacturing industries lowered their already negative assessments of the business outlook. These results confirm that the recovery has lost its momentum and make clear that deflation is indeed taking place. Manufacturers’ planned capital investment for fiscal 2001 (April 2001 to March 2002) comes out 2.4% larger than the figure for fiscal 2000 if software outlays are included, but there is a strong chance that they will be decreasing these amounts later. Profits are expected to improve, but there is little chance that this improvement will lead to higher wages and increased consumer spending.

The administration’s response was delayed by the unsettled political situation, as pressure mounted on Prime Minister Mori Yoshirô to step down, but on April 6 the government and ruling parties adopted a new set of financial and economic policies, including the establishment of an entity to buy up stocks currently held by banks. The main objective of this move is to limit ownership of stocks by financial institutions so that they will not be buffeted by fluctuations in the stock market. The new Bank Equity Purchasing Corp. will buy stocks from banks and package them for resale, probably largely in the form of investment trusts (mutual funds). This is a dramatic move in the direction of unraveling the present web of cross-shareholdings and reforming the structure of Japan’s financial markets. But a number of points remain unsettled, including the questions of when the new entity is to be established, whether the government will invest directly in it, and what is to be done about compensation for possible future losses. The public hopes that the new administration of Prime Minister Koizumi Jun’ichirô will address these unsettled questions with concrete policy measures.

Some assert that this sort of government intervention runs counter to the objective of creating healthy capital markets. Also, there are fears that stepped-up moves by banks to get rid of their nonperforming loans will cause them to call back funds from smaller companies, driving some businesses to the wall. In the worst-case scenario, confidence in the financial sector could once again be shaken. If the government intends to carry through with this program, it will need to decide how to deal with the domestic opposition that it can expect to encounter. Otherwise its plans are liable to end up being watered down, with the result that full-fledged efforts to deal with the situation will once again be postponed. In order to achieve concrete implementation of this package, many specific points will need to be settled, including the rules for debt forgiveness and the assignment of executive responsibility for earlier missteps. Koizumi will have to deal promptly with these issues.

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Returning to the issue of monetary policy, we see arguments over whether quantitative relaxation will promote structural reform or not. The orthodox position is that monetary policy should not be expected to play this sort of difficult role and that structural reform should be undertaken as a separate matter. Some critics also assert that having the central bank buy up long-term government bonds will lead to unrestrained deficit spending. But the task of structural reform can be pursued more readily under conditions of positive inflation than of deepening deflation. The major shift in monetary policy was necessary in order to get the economy out of its deflationary spiral. In order to revive the Japanese economy, as Itô Motoshige points out in his article below, action is required simultaneously on three fronts: monetary policies to counter deflation, structural reform of the financial system (particularly disposal of bad loans), and supply-side measures, such as policies to revitalize urban areas and enliven the stock market. The BOJ’s move represents action on one of these three fronts.

The actual content of the government’s program to deal with the sagging stock market remains unsettled, as I noted above. Sakakibara Eisuke, former vice-minister of finance for international affairs, is critical of the sort of measures the government is aiming to undertake. According to him, the cause of the stock market’s poor performance is not the problem of cross-shareholding but the fact that the structure of Japanese industry has failed to shift; when the pain of restructuring hits the big construction companies and smaller businesses that have traditionally been a major source of support for the Liberal Democratic Party, the political establishment rushes into action with measures to “protect the weak,” thereby delaying the process of reform. This sort of delay has also been pronounced in the public sector. The fiscal investment and loan program has accumulated its own load of nonperforming assets, which are decreasing the value of the postal savings that have served as its main source of funding. If this huge program continues to operate blithely on the assumption that savings will outpace investment, it may end up with nothing but bad assets. On the fiscal policy front as well, the time has come for the authorities to set targets for deficit reduction and to move to achieve them by identifying what appropriations are truly necessary to revive the economy and cutting back on spending that is wasteful.

Some observers have been noting that the delay in achieving reform has distorted the structure of Japanese industry. We include an article by Ikeo Kazuhito, who points out that employment in manufacturing, whose productivity advanced during the 1990s, has been declining, while employment has been on the rise in the construction industry, whose productivity has fallen. This set of developments has lowered the productivity of the economy as a whole. And the cause is the lack of progress toward structural reform. Declining productivity is lowering investment efficiency. This is a sign that growth sectors are not getting the capital they need. It also shows that financial instututions are not properly fulfilling their role of intermediation.

Japan has for the past decade been soaking in a tub whose water is gradually cooling off. Both Mori’s administration and that of his predecessor, the late Obuchi Keizô, poured warm water into the tub, making it even harder to summon the resolve to jump out. But the supply of warm water is not endless. Businesses with foresight have already gotten out of the tub and succeeded on their own. The quantitative relaxation of monetary policy is aimed at stopping the deflationary spiral—it must not be taken as another addition of warm water to the lukewarm tub. The public is eagerly watching to see what concrete proposals Koizumi will come up with to carry out his pledge to undertake sweeping structural reforms. (Nariai Osamu, Professor, Reitaku University)

© 2001 Japan Echo Inc.