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Monday, April 30, 2001

Monetary policies may collide as globalized economy emerges


As the globalization of the world's economies goes on, it will become natural for the monetary policies of one major country to affect the policies of others. After all, money flows across national borders.

The U.S. Federal Reserve on April 18 announced a 0.5 percentage point cut in short-term interest rates, a decision the stock market welcomed with an upward spike. But it must not be forgotten that the cuts were prompted by growing concern over a slowdown in the real economy.

The so-called Old Economy plunged into a recession around the end of last year, although signs of a comeback are emerging as companies moved ahead with inventory adjustments. A slump in the "New Economy" is also becoming noticeable as firms in the sector offer fewer jobs.

The worsening conditions in the real economy are fueling speculation that, despite the 0.5-point reduction, the Fed may have to implement additional cuts when the Open Market Committee meets May 15.

True, personal consumption has not yet dramatically fallen, but that's only because various industrial sectors are lagging in the implementation of their already-announced streamlining programs. Once the programs are carried out, consumer spending will be adversely affected.

We need to watch how the stock market slump will eat into the assets of American consumers amid the continuing shortage in savings. Fed Chairman Alan Greenspan's surprise rate cut was based on his fear that without pre-emptive action, a vicious cycle would ensue in which stock price falls would pressure the Fed to ease monetary policy further.

Under the current conditions surrounding the real economy, the Fed's ability to support stock prices by manipulating interest rates must be closely monitored.

Nearly a month before the Fed's move, the Bank of Japan announced some changes to its monetary policy on March 19.

One of the major features was that it shifted the focus of its policy from the overnight call rate to the balance of commercial bank reserves held at the central bank. In other words, it put greater emphasis on the quantity of money in circulation than on interest rates, making interest rates a variable dependent upon the amount of funds.

The second characteristic is that the BOJ set a quantitative limit on the purchase of long-term government bonds from the market: that it is not to exceed the outstanding balance of bank notes. This was obviously meant to forestall the possibility that the government could demand an unlimited amount of bond purchases, including newly issued bonds.

It is natural that such a ceiling has been set, because the amount of outstanding bank notes is a standard the central bank cannot manipulate.

The third feature is that the central bank committed itself to maintaining the new policies until the consumer price index, which is currently negative, climbs above zero from the previous year.

Overall, the new BOJ policy reassured the private sector, especially the bond-rich financial industry, and may have also encouraged the U.S. authorities to pursue the subsequent rate cuts. However, I have two doubts about the central bank's latest move.

First of all, the BOJ has effectively set quantitative targets on monetary easing, an approach it had vehemently opposed in previous meetings. But the central bank has not provided a convincing explanation of why it changed its position on the matter.

Second, was it really wise to designate the CPI as the only criteria? The BOJ may have wanted to adopt an easy-to-see index, but it should also take into account other factors, such as land prices or ups-and-downs in corporate wages.

Domestically, it is the government's turn to launch new economic policies. We must watch how the Liberal Democratic Party's newly elected leader, Junichiro Koizumi, will steer the government when it comes to structural reforms and fiscal and taxation policies.

On the international front, close attention should be paid to how monetary easing by Japanese and U.S. authorities will affect interest rates for the euro. While some European Union member economies are on the brink of overheating, there have been growing calls from others -- notably Germany -- for monetary easing.

Money moves across national borders and the monetary policies of major powers are becoming more correlated, but such discrepancies can and do exist within a regional economic bloc. We need to watch how the European Central Bank will guide its monetary policy in light of the upcoming Group of Seven discussions.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.


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