Haruhiko Kuroda, the newly installed Bank of Japan governor, has offered the monetary equivalent of shock and awe. Under Mr Kuroda’s guidance, the BoJ now intends to hit a 2 per cent inflation target within the next two years; is committed to doubling the monetary base; is willing to buy bonds of all sorts of maturities; is accelerating its purchase of risk assets; and has gone considerably beyond already elevated expectations within financial markets.
In acting decisively, Mr Kuroda is following a well-trodden path: think of Paul Volcker and his battle against inflation at the beginning of the 1980s or Alan Greenspan and his tussle with equity markets in 1987. Moreover, there has been a willingness to learn from the excessive caution of the past. By buying bonds of more or less all maturities, the whole yield curve has come down. By openly committing to a higher inflation objective, it’s clear that monetary conditions will remain loose for a prolonged period of time. Meanwhile, Shinzo Abe, Japan’s prime minister, seems keen to avoid a UK-style inflation trap, emphasising that a healthy escape from deflation requires not just higher prices but also higher wages.
So far, so good. The commitment is most definitely there and the ambition has now been well-defined. Yet Japan is not yet out of deflationary trouble and, even in the event of the monetary equivalent of the Great Escape, it might still all end in disappointment.
The first – and most obvious – problem is that Japan’s difficulties do not reflect an absence of monetary and fiscal stimulus alone. Offshoring, ageing, the unproductive use of women in the workforce and an acutely cautious attitude towards immigration have all played their part in constraining Japanese growth during its two lost decades. A wave of the monetary magic wand cannot fix those problems.
The second difficulty relates to leakage in what is known as the carry trade, in which an investor borrows money at a low interest rate in order to invest in an asset that is likely to provide a higher return. It may be that borrowing costs in yen are now remarkably low relative to Japan’s own history but, over the past two decades, they have always been low relative to interest rates elsewhere. Over that period, attempts to boost the Japanese economy have too often seen the benefits spilling over to other parts of the world, creating unwanted hot money inflows, overvalued currencies and unsustainable financial bubbles, even as the Japanese economy has remained trapped in a deflationary hole.
The third challenge relates to the performance of the yen and, more generally, the transmission mechanism of monetary policy. There’s a potential inconsistency between the Japanese view of monetary stimulus (it lifts domestic demand and rebalances the economy towards domestic consumption) and the – whispered – UK view (it lowers the exchange rate and rebalances the economy towards exports). In the UK’s case, the rebalancing never came to pass and, arguably, a lower level of sterling only led, via higher import prices, to a squeeze in real wages. In Japan’s case, previous experiments with QE – admittedly not on the same grand scale – mainly served to boost exports without any significant impact on domestic demand. In a world where other nations are struggling for growth, a yen-induced export-led Japanese economic recovery might not be enthusiastically received. And, despite Mr Abe’s hopes of higher wages, it may be that rising import prices ultimately only serve to squeeze real incomes.
Mr Kuroda has got to first base. He has yet to score a home run.
The writer is HSBC’s group chief economist. His new book, ‘When the Money Runs Out: The End of Western Affluence’, will be published by Yale in May