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Monday, July 25, 2005
Right for the wrong reasons: deflation dilemma at the BOJ
By NORIKO HAMA
What do you do when things turn out right for all the wrong reasons? Do you laugh? Do you cry? Do you do a bit of both, or none of either? This must be the kind of mental acrobatics that observers of consumer price developments at the Bank of Japan are going through at this particular moment.
A growing body of evidence suggests that Japan's consumer price index will stop declining sometime within what remains of this year. The news is obviously welcome for the BOJ, given that consumer prices have to stop declining before the central bank can go about putting an end to its prolonged policy of "quantitative easing."
Under this policy, huge amounts of excess liquidity are being pumped into private-sector banks' deposits with the BOJ. The policy is increasingly outliving its usefulness and consequently becoming more and more difficult to maintain.
During the height of the nonperforming-debt crisis, banks had to be braced for all kinds of uncertainties and contingencies. Hence they felt the need to boost their reserve positions.
Now that the atmosphere of crisis has receded, they are much less responsive to the BOJ's moves to supply them with extra liquidity.
Yet the BOJ has committed itself to its current policy until such time as when "the rate of consumer price changes over the previous year is persistently zero percent or more." No matter how out of place and difficult to maintain the quantitative easing policy becomes, the policy cannot be withdrawn unless and until consumer prices stop declining.
So when evidence begins to mount that consumer prices are about to change course, this should make happy people out of our central bankers. However, take one look at the nature of the evidence and things begin to appear slightly different.
One such piece of evidence is developments in phone line charges. Between November 2004 and January of this year, telecommunications providers went in for heavy cuts in the rates they charge to conventional fixed-line users. As a result, the monthly price index for this particular item has been dropping by more than 10 percent year on year since the beginning of the year. But come November, this "base effect" will largely drop out of the calculation.
A similar situation exists in the price of rice, that all-important item in our food supply. Rice prices have also been declining substantially on a year-on-year basis since January. But this was because price levels were very high up to last autumn due to a poor harvest the previous season. Given lower overall price levels from around October onward last year, rice prices should also start to register positive growth from the autumn months this year.
The other important factor that is changing the consumer price outlook is, of course, oil prices.
With phones and rice, it was a case of downward price pressures easing. But with oil prices, it is a case of new upward pressures entering the equation. With downward pressures easing and upward pressures increasing, the argument does indeed sound convincing that consumer price deflation is about to become history.
Yet was this really how it was supposed to happen?
The disappearance of one-off reductions in people's phone bills and rice price swings due to irregular harvests do not sound quite like the right reasons for making changes to monetary policy.
As for oil prices, if they rise too much for too long, that could easily become yet another factor that plunges the economy back into deflation all over again. What will the BOJ do then?
Right and wrong are tricky things to contend with in policymaking.
Noriko Hama is an economist and a professor at Doshisha University School of Management.