BoJ’s headwinds complicate economic recovery

TOKYO: No one probably is more disappointed by Japan’s tepid growth than Toshihiko Fukui. The Bank of Japan governor effectively declared victory over deflation in March, when he scrapped a five-year experiment with “quantitative easing”. In July, the BoJ raised interest rates for the first time since August 2000.

Both steps reflected Fukui’s desire to return some normalcy to Japan. After all, no central bank, let alone one governing a nation in the Group of Seven, should ever cut rates to zero, as Japan’s did. Yet, Japan still isn’t a normal economy and growth isn’t roaring ahead as anticipated.

Rather than accelerating, as Mr Fukui expected, Japan’s revival is losing speed. Japan grew an annualised 0.8% in the three months ended September 30, less than the 2% shown in a preliminary report and the second-quarter’s 1.1 growth rate. The reason: consumers aren’t spending more.

Instead of rising as the BoJ expected, inflation is pretty much nowhere to be found. Core consumer prices, which exclude fresh food, rose 0.1% in October from a year earlier, the slowest pace in five months.

With 2006 looking like anything but a good year for the BoJ, here are two suggestions for managing the world’s second-largest economy in 2007. One, be patient. Two, stop talking. The first suggestion is clear enough, given the obvious itchiness of the BoJ’s trigger finger this year. It should let inflation as measured by a number of barometers gain some traction before worrying about keeping it under wraps.

“Why are they in such a hurry?” asks David Cohen, Singapore-based director of Asian economic forecasting at Action Economics. “The Bank of Japan keeps saying they have to be `forward looking’, but give me a break — prices aren’t exactly spiraling out of control.”

The lessons of 2000 will be worth considering on December 19, when the BoJ concludes its final policy-making meeting of the year. That was the year in which the BoJ raised rates from zero and reversed course 10 months later when it was clear the move was exacerbating deflation.

Japan in 2006 is far healthier than in 2000, and the BoJ’s 0.25 percentage point move in July need not tip the economy back into recession. Even so, Japan needs every tailwind it can get amid expectations for slower global growth in 2007.

Instead, the BoJ’s actions are acting more like a headwind. It was John Maynard Keynes who spoke of the importance of “animal spirits” in economics, and these spirits also could apply to central banks.

As much as inflation is a monetary phenomenon, it’s about expectations, perceptions and gut feelings. If people believe inflation is likely, its emergence is more plausible.

That brings us to the second suggestion: silencing the BoJ. This being the age of central-bank transparency, Mr Fukui and his deputies seem to think they must telegraph their every move, temptation and thought. Rather than providing insight, these comments have tossed an element of sensory overload into markets and muddied the message.

As 2006 draws to a close, it is clear the BoJ prematurely declared an end to deflation. With each passing report showing scant inflation pressures, the BoJ’s insistence that price increases are coming hurts its credibility. And central banks that cut rates to zero in the first place have little credibility anyway. It’s getting to the point where no investor in his or her right mind would trade on what the BoJ says about price trends.

Japanese officials love to talk. Some have been known to give impromptu press conferences while walking to press conferences. With all the public speaking officials do, I often wonder when they find time to manage the economy. Yet, inflation expectations must be based on hard data like the consumer price index, not what central bankers say.
“The lack of any signs of a pick-up in the CPI continues to stand in the way of the BoJ’s next rate hike,” says Tetsufumi Yamakawa, chief economist at Goldman Sachs Group in Tokyo.

That’s a good thing. The question is whether the BoJ has blunted the effect of Keynes’s animal spirits. The longer those forces stay in hibernation, the longer Japan may operate below its potential and be vulnerable to the whims of global growth. Japan’s recovery is too much about exports and not enough about consumption and it still is too reliant on massive government stimulus funded with debt.

What’s intriguing is how silent the government has gone on the BoJ. Two months ago, it was received daily guidance from politicians worried it was tapping on the brakes too soon. That we are hearing less jawboning suggests the BoJ already is being set up to take the fall if growth fizzles.

Markets tend to loathe politicians criticising central bankers. In this case, politicians are right to be worried. Monetary policy is as much about influencing perceptions as the money supply. The BoJ is too concerned about a problem Japan doesn’t have (inflation) and not enough about one it does (stagnant prices). Worse, BoJ officials are publicly expressing their misdirected attention all too often.

Japan’s return to normalcy is a work in progress. Yes, banks are stable, corporate profits are up and jobs are being created. Yet, consumer spending hasn’t recovered. That’s a key vulnerability; Japan’s ability to get households to save less and spend more has long been the key to boosting growth. Neither rash actions nor talk will get Japan to that point. The year ahead offers the BoJ a chance to be more of a help than a hindrance.