No. 16 — April 21, 2000


Weekly Review

--- by Arthur J. Alexander

Bank of Japan Governor Masaru Hayami caught the attention of global financial leaders assembled in Washington April 16 and April 17 for the spring meetings of the International Monetary Fund and the World Bank — not to mention that of Tokyo — by suggesting April 12 that the central bank's 15-month-old policy of zero interest rates could be abandoned within the year. At a regularly scheduled press briefing, he echoed BOJ's latest assessment of current economic conditions, released that day, which pointed to several positive signs, most notably, a rise in corporate investment. When asked by a reporter if this view might be interpreted as an indication that BOJ plans to raise interest rates, Mr. Hayami's response was oblique: "There are likely to be many who make such an interpretation and I don't think that would be wrong."

Close readers of the minutes taken at the monthly meetings of BOJ's Policy Board already had noted that the preconditions for tightening monetary policy were well on the way to being met, although board members avoid the term "tightening," referring instead to "the ending of abnormal policies." Over the past month or so, Mr. Hayami had listed a number of signals, the presence of which would justify scrapping BOJ's zero interest-rate policy (see JEI Report No. 34B, September 3, 1999). The conditions included dispelled deflationary concerns, increased domestic demand, recovered personal consumption and stabilized corporate earnings. In short, the economy should show signs of an autonomous recovery, driven by domestic private demand, that would result in a narrowing gap between productive potential and actual output.

The minutes of the March 8 Policy Board meeting, the most recent ones released publicly, described clear improvements in each of the mentioned areas. More important, the summary of opinions indicated optimism, noting that members generally agreed with the following view: "Japan's economy has recently started to improve. However, clear signs of a self-sustained recovery in private demand have not been observed yet." The latter caution, which had been included in a formulaic way in the write-ups of the group's deliberations for several months, was dropped in BOJ's April economic review.

As Kremlinologists once scrutinized the slightest changes in statements issued by the Politburo for clues to Soviet-era policies, BOJ watchers look for portents in official utterances. Although the meaning of Mr. Hayami's press conference statement was clear, the action referred to an indefinite future period. Some observers are betting now that a 0.25 percentage point increase in the overnight rate could come in the fourth quarter of 2000.

Although any move is unlikely for at least six to nine months, Mr. Hayami's comment created an uproar at the Ministry of Finance and raised eyebrows among the finance ministers and the central bankers of the Group of Seven industrial countries gathered in Washington before the IMF-World Bank meetings. Finance Minister Kiichi Miyazawa later told a press conference that discussions with the BOJ chief indicated that his remarks "stemmed from his desire to communicate his outlook for the future." This interpretation is consistent with Policy Board discussions about the appropriate method for ending the current zero interest-rate policy without sparking excessive reactions in financial markets.

Nevertheless, according to the Finance minister, the BOJ governor's statement "was a bit of a headache for those who will participate in the G-7 meeting. Unlike Mr. Hayami, the United States and the International Monetary Fund still have concerns about deflationary pressures in Japan." One of Mr. Miyazawa's worries was that because higher interest rates could be expected to push up the value of the yen, a tighter monetary policy would undercut his own attempts to get fellow G-7 finance ministers and their central bank colleagues to issue a statement of concern about an overly strong yen. In the end, the communique issued at the conclusion of their April 15 talks stated merely that exchange rates should reflect economic fundamentals.

MOF decisionmakers also are concerned that the ongoing financing of Japan's huge government deficits by issuing bonds will tend to drive up interest rates and possibly choke off the economy's recovery unless monetary policy continues to remain as loose as it has been for the past year or so. Moreover, since Tokyo is not now planning a large supplementary FY 2000 budget to stimulate the economy, monetary policy is the main tool available for supporting the nascent economic expansion.

Other top government officials repeated Mr. Miyazawa's concerns. Economic Planning Agency chief Taichi Sakaiya, for example, called it premature to contemplate ending BOJ's current monetary policy stance in light of still-unfavorable conditions in the job market and in consumer spending.

In Washington, Secretary of the Treasury Lawrence Summers said that Japan's achievement of domestic demand-driven growth was imperative and that any shift from that goal would pose an unnecessary risk to the global economy. Acting IMF Managing Director Stanley Fischer and Economic Counselor Michael Mussa, who directs the fund's research, quickly chimed in with supporting warnings against any tightening of monetary policy in Japan.

In their communique, G-7 finance ministers and central bankers urged Tokyo to keep interest rates as low as necessary as part of a call for continued structural reform in Japan and in euro-zone countries. The statement also noted that "the Japanese economy has not yet achieved a secure recovery in private demand."

Editorial commentary in London's Financial Times theorized that the G-7 evaluation was designed to support MOF against BOJ. In fact, the communique went even further and specifically mentioned BOJ's plan "to continue, in the context of their interest rate policy, to provide ample liquidity in money markets. The communique reflects our common view, including the view of the Japanese representative." Mr. Hayami, who attended the April 15 meeting, later said that he was comfortable with the language of the statement and pledged to maintain BOJ's ultraeasy monetary policy for as long as it took to end deflationary pressures. Some observers read this sequence of events as a policy defeat for the independent central bank, although there may have been some overinterpretation of Mr. Hayami's original remarks on future tightening.

Meanwhile, the growth of the monetary base — the money aggregate controlled directly by BOJ — has shown distinct signs of acceleration recently. Although month-to-month changes in this series often are difficult to discern because of strong seasonality combined with high underlying volatility, a five-month centered moving average of seasonally adjusted figures shows a rise in the monetary base above 8 percent since November, with increases to 10 percent or more in 2000.

The growth of the broader monetary aggregate, M2+certificates of deposit, which depends as much on the demand for credit as on the supply, had been decelerating almost continuously since 1998. The monthly change in this smoothed, seasonally adjusted figure stood at an annualized 6 percent in January 1998, but it fell to as low as 0.8 percent in January 2000. In February and March, though, M2+CDs increased at a rate closer to 2 percent, which is not spectacular but is more comforting to those looking for any sign of quantitative easing.

At its March meeting, BOJ's Policy Board finally agreed to direct its staff to examine the technical issues surrounding a policy of inflation targeting — an approach to controlling the money supply that many foreign monetary economists as well as certain Liberal Democratic Party influentials have been urging on Japan's central bank. With one exception, board members have strongly opposed the announcement of an explicit inflation target. Their caution reflects a variety of technical and political reasons. Chief among them is that the failure of such a policy — which is unavoidable, according to these insiders — would tarnish BOJ's reputation and reduce its authority and effectiveness.

The central bank has been trying to raise its status in the two years since it gained institutional independence from MOF. Accordingly, it has acted conservatively, believing that any policy failure would damage that goal. Now that BOJ has a track record and has demonstrated its independence, the Policy Board apparently feels that it is time to consider other approaches to supporting the economy's recovery, especially if the current phase of monetary policy may be drawing to a close.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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