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Monday, Feb. 3, 2003

JAPANESE PERSPECTIVES

Beware of the risks of inflation targeting


America borrows to keep growing. China grows to keep standing still. And Japan stands still to keep from falling apart.

America needs to import goods from abroad to satisfy the ever insatiable appetite of its consumers, its companies, and increasingly, its military. To pay for those imports, it needs to keep borrowing from abroad.

At 7 percent or more, Chinese economic growth is the envy of the world. Yet that growth is a necessary prerequisite for absorbing all the disparities and the divides that exist within that very large economy.

We each have our own problems of survival. But Japan's is the trickiest of all.

For we have driven ourselves into a corner where each move in whatever direction causes the cracks in the system to deepen and to widen. Go for structural reform, and a lot of people become unemployed. Resort to monetary easing, and pensioners' incomes suffer. Attempt more fiscal stimulus and what suffers is the value of Japanese yen-denominated assets.

One of the would-be solutions that is getting a lot of attention in this paralytic situation is inflation targeting. This device, designed to get inflation under control, is being advocated as a means of resolving deflation.

It has to be said that under the current circumstances, really anything might be worth a try. Yet there is such a thing as asymmetry in economic cause and effect. What works one way is not guaranteed to work in the other direction.

Even in the unlikely event that the targeted rate of inflation does indeed materialize, or more precisely, even if such inflationary expectations actually take hold of people under inflation targeting, it is difficult to see this stimulating consumers into spending and companies into investing in Japan's current environment.

Inflation over and on top of all the uncertainties and financial complications that people face currently is, if anything, likely to frighten the public into an even tighter hold on their purse strings.

It might be another matter if the Japanese economy was not such a mature and saturated one. Two percent inflation tomorrow is not going to make households that already have a car and a mobile phone for every one in the family to rush to buy yet another one of those pieces of machinery today.

Moreover, pumping money into the economy in order to nudge spending out of deep-freeze is an attempt that has been going on for ages here.

Targeting a specific rate of inflation makes no difference in this respect. For it to make a difference, a change has to occur in the way that money is pumped into the economy. In other words, the Bank of Japan will not only have to force more cash on private-sector banks and buy more Japanese government bonds, but it will have to invest in other riskier assets as well.

In the end, it is not likely to be the targeted rate of inflation that matters, but the amount of money that goes into the direct buying of risk assets by the BOJ. If that be the case, what all of this amounts to is a massive spending operation by the BOJ to do what the government is unable to do because of its outstanding debt obligations.

The Bank of Japan in this context begins to look increasingly like Antonio of Merchant of Venice fame, who undertakes to risk his fortunes for the adventurism of his amorous friend.

For a central bank to stick its neck out thus far runs totally counter to its obligation to uphold the value of the money that it prints. This is not the kind of self-sacrifice we expect of central banks if they mean to be true friends of the public.

Noriko Hama is an economist and a professor at Doshisha University School of Management.


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The Japan Times

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