What will it Take for the Government and the Bank of Japan to Unite? - Just as Important as Who will Head the BOJ and Whether or not to Introduce Inflation Targeting -

UESUGI Iichiro
Fellow, RIETI

On March 19, Bank of Japan Gov. Masaru Hayami and two deputy BOJ governors will step down and be replaced by a new team. As the Cabinet prepares to appoint the governor and deputy governors of the central bank, there has been a great deal of media speculation as to whom Prime Minister Junichiro Koizumi has in mind as the new head of the BOJ. The terms of the BOJ governor and deputy governors run for five years and, once appointed, the Cabinet cannot dismiss them for disagreeing with government policy. Therefore, this surely is a critical decision.

Implications of arguments surrounding inflation targeting

Some have argued that in selecting the next BOJ governor, candidates should be tested for their stance on inflation targeting. Given the fact that the new governor's term runs through 2008, that would be a rather shortsighted and topical standard. Regardless of its validity as a test for selecting the new governor, however, whether or not to introduce inflation targeting at all has once again become the subject of heated debate. Opinions are divided between two major camps, firstly those who call for introducing inflation targeting based on the belief that the move will increase transparency of policies and change people's expectation of the future and secondly those who are reluctant about the idea because they are unsure whether such a target can be realized and fear that the scheme may end up further destabilizing economy.

The more important question posed by the ongoing debate surrounding inflation targeting, however, might be whether or not the government and the BOJ are truly united, rather than just whether or not to introduce the scheme. Of course, the government and the BOJ supposedly "act as one to overcome deflation and turn price growth positive as soon as possible." This phrase, taken from the government's 'Fiscal 2003 Economic Outlook and Basic Stance for Economic and Fiscal Management', is loaded with the various thoughts of policymakers who strenuously negotiated for an agreed wording.

However, if the government and the BOJ were truly acting as one, why did Gov. Hayami say, "Prices will not rise unless the economy improves and we will maintain easy monetary policy under the current framework" when asked why he thinks inflation targeting should not be introduced? And why did Minister Heizo Takenaka, during the Dec. 17 BOJ Policy Board meeting, say "Expectation is inevitably high on the BOJ in regard to the problem of deflation," urging the central bank to take action? Judging from these two remarks, it seems that whatever thoughts are loaded on the phrase "the government and the BOJ will act as one" they have not materialized.

Why does it appear that the government and the BOJ are not truly united?

It may be the case that the oneness between the government and the BOJ is hard to see because both the ongoing deflation facing the Japanese economy and policies prescribed for the problem are totally different from those in the past. The ongoing deflation problem cannot be resolved by either the government or the BOJ acting alone. The central bank, which has already guided down the overnight call rates to zero, is being urged to take additional easing measures to increase liquidity in the money market. Specifically, the BOJ is being urged to purchase exchange-traded funds (ETFs) linked to the TOPIX index and somewhat risky corporate bonds, or to buy long-term Japanese government bonds (JGBs) without limitation. Given these circumstances, the BOJ may be tempted into voicing its objections. The BOJ may want to say that lending to risky companies should be made by quasi-governmental financial institutions. Or, when nudged to buy more long-term JGBs, it may want to ask just who keeps on issuing all these bonds.

Policy accord is necessary to restore the sense of unity

Now is the time for the government and the BOJ to work out and implement concrete measures. More specifically, it is necessary to first decide what measures must be taken by either the government or the BOJ, and then to draw clear lines between their respective responsibilities. This is not to simply distinguish their roles and responsibilities on certain specific measures but to draw a comprehensive map that clarifies their respective roles and responsibilities on all necessary measures. There will be disputes over whether it should be the government or the BOJ that commits to setting an inflation rate or other macro economic targets and which of them should be responsible for implementing concrete measures - disposal of bad loans, establishment of a safety net, purchasing of corporate bonds with low credit ratings or other risky assets, measures to support corporate finance, purchasing of foreign bonds or whatever else - to achieve the inflation target. Establishing distinct lines between the government and the BOJ on all these issues can be described as a "policy accord" in the sense that the parties promise each other what measures they will undertake.

Discussions for such a policy accord are at least more comprehensive than discussions over whether or not to force the BOJ to introduce inflation targeting, and meaningful as a method of restoring the sense of unity between the government and the central bank. Furthermore, these are the issues that must be discussed anyway, regardless who will become the next governor of the BOJ.

Toward discussions on policy accord

In order to realize a policy accord that is workable and effective, both the government and the BOJ must be specific in their promises and a mechanism for ensuring that each of them fulfills its commitment should be created. Also, as the BOJ's independence from the government is stipulated in law, it is necessary to discuss what kind of policy accord is possible, without impairing the independence of the BOJ, to attain their common goal of overcoming deflation. (For more detailed arguments, please refer to "The Government and the BOJ should Make a Policy Accord to Pull Japan out of Deflation" [Japanese only] in the Policy Discussion column.)

Of course, making a policy accord is no easy task. Although I have confined my discussion here to issues between the government and the BOJ, the government, in many other cases, is unable to make any promises without going through certain political procedures and then gaining the approval of the Diet, typically through the budgeting process. It will surely require a comprehensive scheme to realize a policy accord given the realities of the complex political process.

Still, if we keep on avoiding debating these issues, the phrase "the government and the Bank of Japan will act as one" sounds hollow. I do count on continuous, strenuous efforts by policymakers.

(This article was written before the government formerly announced Mr. Fukui would be the next BOJ governor.)

February 18, 2003

February 18, 2003