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Friday, Feb. 11, 2000

BOJ's ultraeasy-credit policy a double-edged sword

Staff writer

As the Bank of Japan carries its zero-interest rate policy into the second year, there is no sign that the policy the BOJ itself calls abnormal will end anytime soon.

The central bank eased its monetary stance to an unprecedented level one year ago today, lowering the key short-term interest rate effectively to zero.

Thanks in part to the policy, the economy has undoubtedly shown some signs of improvement, but the degree of improvement has not yet compelled the BOJ to end its ultraeasy stance. On Thursday, the bank's policymaking board decided by a majority vote to keep the zero-rate unchanged.

What it means is that banks can raise money effectively for free anytime they want. The move is intended to spur economic activities by making it easier for firms to borrow from banks.

While the zero-rate policy has been hailed for helping stabilize what had been a shaky banking sector as well as prompting a recent upsurge in the stock market, economists warn that it should not be taken for granted.

Akio Makabe, chief economist at Dai-Ichi Kangyo Research Institute, noted that although the BOJ had no alternative at the time it adopted the policy, it is abnormal.

"Nobody wants trash, and everyone wants money," Makabe said. "For the bank to make the price of money zero goes against the price mechanism of a capitalistic economy."

The zero-interest rate policy works in favor of people and institutions in debt, because it reduces their interest burden. But it also has side effects.

While it weighs heavily on depositors and pensioners by shrinking their interest income, banks, which have also benefited from the ultralow interest, also face risks.

With so much excess money at hand, banks are still unable to boost their lending because businesses are trying to pay off their debts and are not willing to make new investments in plants and equipment.

So banks have increased their volume of investment in government bonds, and this could spell trouble for the banks if the economy ever begins a full-scale recovery, said Shu Tamaru, chief economist at Industrial Bank of Japan.

"As the economy recovers, long-term interest rates are bound to rise, which in turn pushes down the value of government bonds," he said. "By investing more in government bonds, banks are increasing their danger of incurring losses in the future."

For the BOJ, the past year was marked by a series of battles against political and market pressures. The most symbolic event took place in September in a confrontation between the Finance Ministry and the BOJ.

Around that time, the yen was rising rapidly against the dollar, threatening a nascent economic recovery by shrinking the profits exporters gained abroad.

The Finance Ministry, which controls the timing and scale of currency market intervention and has the BOJ execute its orders, failed to stem the yen's appreciation through solo-intervention.

Exasperated, the ministry asked the bank to start "quantitative easing" — which goes beyond the current zero-rate policy, financial sources said.

It is widely believed that the ministry considered further credit-easing by the BOJ as a prerequisite for squeezing out an acknowledgment by the Group of Seven nations that the yen's rapid appreciation is hurting Japan's economy.

But the BOJ rejected the ministry's call.

On Sept. 21, in its policymaking board meeting just before the G7 meeting in Washington, the BOJ announced it would not change the zero-interest rate policy, saying the "foreign exchange rate in itself is not a direct objective of monetary policy."

But this further hurt the bank's relations with the ministry. As criticism against the bank mounted toward the G7 meeting, the BOJ apparently softened its stance on monetary policy — although it would not publicly admit it.

During the G7 meeting, the BOJ released a rare statement, saying the bank will use flexibility to "respond appropriately and in a timely fashion to developments in the economy as well as financial markets, including the foreign-exchange market."

Experts say the September ordeal showed that the ministry and BOJ are inherently at odds.

"The Finance Ministry and BOJ do not get along because they have different interests," DKR's Makabe said. "If the ministry loosens its purse to kick-start the economy, the bank can reserve a card for later use, and vice versa."

Through its battle with outside pressure, the bank must have learned one important lesson: It needs to boost transparency in its operations or nobody will understand what it is trying to do, let alone support it.

The same lesson will be handy the next time the BOJ tries to raise interest rates.

Recent signs suggest the BOJ is preparing such a move. One senior BOJ source recently said the bank should "quit the (zero-interest rate) policy soon because it is abnormal."

BOJ watchers also note that the bank has publicly indicated it is preparing for credit-tightening.

In late December, Hayami said in a speech in Tokyo that he "wants to win the battle against deflation as soon as possible." Makabe said this comment, coupled with another remark made the same month by BOJ Vice Gov. Sakuya Fujiwara, indicates the BOJ has started preparing to abandon the zero-rate policy.

But a rate hike is unlikely to come easily. Some observers rule out the possibility that the current policy will be abandoned by the end of the year.

"If the BOJ abandons the zero-rate policy now, long-term interest rates will go up, stock prices will go down and the yen will rise against the dollar," said Yuji Shimanaka, chief economist at Sanwa Research Institute. "All of these factors will set the stage for a steep decline in U.S. stock prices," which would send the world economy into a tailspin.

Shimanaka, an advocate for quantitative easing, said the BOJ should go further than just continuing the zero-rate policy.

The bank should start directly targeting an increase in money supply or significantly step up its outright purchase of long-term government bonds, he said.

In that way, the amount of money the bank uses to buy bonds will stay in the market.

Recent moves by a Liberal Democratic Party panel to study inflation targeting also indicate the central bank is being warned against a rate hike in the near future. Countries including Great Britain, New Zealand and Canada currently have inflation targets, under which the central banks aim to reduce inflation, not foster it.

Behind the panel's moves lurks a desire by lawmakers to keep interest rates low until after the next general election; many politicians are backed by construction firms, which are saddled with enormous interest-bearing debts.

Economists predict that the next pivotal time for the BOJ to review its policy will be at the end of August, when ministries submit their budget requests for fiscal 2001 to the Finance Ministry.

The government's fiscal stance — expansionary or restrained — will become clear then, IBJ's Tamaru said, adding that the BOJ will be expected to coordinate its policy with that of the Finance Ministry.

"If it becomes obvious that the government will compile another expansionary budget in fiscal 2001 to prop up the economy, the BOJ will have no chance of changing the zero-interest rate policy," he said. "On the other hand, if the government tightens its budgetary stance (in view of the rising fiscal debt), I think there is a 70 percent or greater chance that the BOJ will change its stance soon afterward."

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The Japan Times

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