Challenges Confront the New BOJ Governor: A Revised Approach to Monetary Easing and the Risk of Surging Rates
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Loading... - Bojing Liu
- 04 Apr 2023
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The direction the Bank of Japan will take under new leadership is attracting the interest of markets in Japan and around the world. The primary reason for this is the way higher resource prices is increasing upside pressure on prices in Japan, which is driving the BOJ to transition away from its monetary easing “of a different dimension.”
What has placed the BOJ in this predicament? The culprit is the 2% inflation target of Abenomics, a mistaken policy from the start. While the loosening of fiscal discipline had an even larger negative impact, structural factors are to blame for the sluggishness of prices in Japan. To achieve a 2% inflation target through monetary policy alone was all but impossible.
This situation can be confirmed by examining the past movements of the rate of inflation (consumer price index). While the CPI was pushed up by 1.4 percentage points with the introduction of a consumption tax in 1989, hitting 4.9% in 1990, the average annual rate of inflation was only 0.6% during the asset bubble years of 1986–89, when Japan’s economy overheated. Prices were impacted by the Gulf War in 1990 and 1991, by the increase of the consumption tax rate in 1997, and by the sharp rise of crude oil prices in 2008. When these factors are excluded, 1985 was last time inflation exceeded 2% in any normal year up to 2013, when monetary easing of a different dimension began.
How, then, do prices differ structurally in Japan? This is readily understood by comparing the difference between the US and Japanese rates of inflation. For example, by taking inflation for August 2019 and dividing it into the rate for goods and that for services, we see that there is little difference in the rate of inflation for goods between Japan and the United States, increasing 0.3% for the former and 0.2% for the latter.
However, when we consider the rate of inflation for goods and services together (CPI for all items), prices rose 1.7% in the United States but only 0.3% in Japan. Excluding foods and energy from the CPI for all items, the rate of inflation was again higher in the United States (2.4%) than in Japan (0.6%).
This difference in inflation arises from the rate for services being higher in the United States (2.7%) than in Japan (only 0.2%). Sectors where this difference is particularly large are water and sewage services, day-care fees, long-term-care fees, university fees, and hospital services. Unlike the situation in the United States, these are sectors in Japan that are strongly influenced by the government.
What this situation tells us is that the sluggishness of prices in Japan is the result of structural factors accompanying government price controls rather than being an issue of monetary policy. Read More…
