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Monday, Aug. 21, 2000

Welcome end to the zero-rate policy


Special to The Japan Times

The Bank of Japan lifted its zero-interest-rate policy Aug. 11, despite strong resistance by the government, which exercised its right for the first time under the new BOJ law in its unsuccessful attempt to have the vote by the central bank's Policy Board postponed. One week later, the Nikkei-225 average on the Tokyo Stock Exchange is back again in the 16,000 range, and no major turbulence has been observed in the currency-exchange rates. Some lawmakers and economic experts criticized the BOJ for "lack of communication" with the financial markets, but the reaction so far indicates that the central bank's message has quite sufficiently been understood by market players.

In both Japan and overseas, there was widespread criticism that the BOJ made its move prematurely or as a mere gesture to "secure its independence" from government interference. Many such comments appear to have been the result of a lack of understanding of the central bank's objectives. What the BOJ wanted to do was to lift an emergency rescue measure that had been introduced, in the absence of a financial safety net, to avert a systematic financial crisis. Under the zero-rate policy, whatever amount of liquidity provided to the market was effectively deposited back with the BOJ, and the short-term money market failed to function properly. This is what BOJ Gov. Masaru Hayami described as "reality of the market" during his testimony to the Diet. Something had to be done to restore the money market's functions, and it was an extraordinary situation in a market economy that money could be raised at zero cost.

Following a series of legislative actions that established a financial safety net, such an extraordinary state of affairs needed to be terminated. The BOJ's decision was long overdue.

The official discount rate remains at a record-low 0.5 percent, and the central bank continues to provide ample liquidity to the market.

But structural reforms are essential for this liquidity to be absorbed by domestic economic players. In fact, restructuring efforts by private-sector firms have been making progress. Japanese consumers are reluctant to spend because they are worried that the widening public-sector debt could prompt the government to increase their tax burden. The government and the ruling Liberal Democratic Party have belatedly started reviewing inefficient public-works projects. In any case, policymakers should realize that the key to economic recovery rests with fiscal, rather than monetary, authorities.

Finance Minister Kiichi Miyazawa must have been fully aware of all this, because he reportedly told reporters after the Aug. 15 Cabinet meeting that the row over the BOJ policy was "already over." If so, Miyazawa should have tried to persuade LDP leaders to accept the BOJ decision in advance. Failing to do so, he should have attended the BOJ meeting himself to demand postponement of the policy-decision vote. It was the government side, not the BOJ, that failed to make enough efforts to communicate.

The fiscal reform law has introduced market principles into fundraising by government-affiliated financial institutions. In fiscal 2001, government bond issues are estimated to top 90 trillion yen (newly issued bonds and refunding bonds), in addition to the 30 trillion yen worth of newly issued bonds by public-sector banks. These will add upward pressure on long-term interest rates.

Of course, the BOJ was less than clear in its logic behind the policy change. The central bank cited "receding deflationary fears" as the main reason for lifting the zero-rate policy. Rather, the BOJ should have explained how the zero-rate policy had been introduced to avert financial system uncertainties -- and how it should be lifted now that legal safety nets have been established. It should have explained how the short-term money market was losing its function, and how the nation's trading conditions have been rapidly deteriorating and raw material prices have been showing double-digit increases due to the surge in crude oil prices.

After all, the difference between Miyazawa and Hayami does not appear to be as serious as has been claimed by some politicians and members of the media, who unduly played up the dispute.

Teruhiko Mano is an adviser to BOT Research International Ltd.


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