Bank of Japan’s Quest to Spur 2 Percent Inflation
(Bloomberg) -- The U.S. Federal Reserve, the Bank of England and the European Central Bank are among the world’s monetary authorities that have set an inflation target right around 2 percent. Nowhere, though, does the quest for this number carry drama like it does in Japan, where Bank of Japan Governor Haruhiko Kuroda has vowed to do whatever it takes to hit it.
1. What’s so special about 2 percent?
The BOJ set its inflation target at 2 percent in January 2013, less than a month after Prime Minister Shinzo Abe came to power with a plan to pull the economy out of two decades of stagnation. In Japan and many other developed economies, prices rising by 2 percent a year is seen as optimal for encouraging companies to invest and consumers to spend. It’s also thought to be low enough to avoid the risk of sparking runaway inflation.
2. How close has Japan gotten to 2 percent inflation?
Not very, if you exclude the impact of a sales-tax hike that took effect in 2014. Inflation has inched upward since the end of 2016, briefly touching the halfway mark of 1 percent in February of 2018 before dropping off. Prices are still rising, but at nowhere close to the rate the central bank would like to see.
3. What caused deflation in Japan?
It began with the bursting of one of history’s biggest real estate and asset-price bubbles. Wounded banks curbed lending, companies focused on cutting debt, wages stagnated and consumers reined in spending. Households became accustomed to falling prices and put off purchases. In later years, the global financial crisis of 2008 and the devastating earthquake, tsunami and nuclear meltdown in 2011 entrenched what Kuroda describes as a “deflationary mindset” among consumers and companies in Japan. The nation’s aging and shrinking population is now making matters worse.
4. What has Kuroda done to change this?
To spur prices, the BOJ embarked on an asset-purchase program of unprecedented scale. And then it expanded it, increasing the amount of money in Japan by about 80 trillion yen ($730 billion) a year. That figure remains the BOJ’s official target for annual asset purchases, but in reality the pace of buying has slowed as the focus of its monetary stimulus shifted to interest rates.
Kuroda first added an interest-rate dimension in January 2016 by charging financial institutions 0.1 percent -- a negative interest rate -- on a portion of the funds they park at the BOJ. This was meant to encourage them to put the money to work more productively. He fully shifted the focus to rates in September 2016 with the introduction of yield-curve control, by which the central bank would adjust the volume of its asset purchases in the short term to control bond yields.
5. Why hasn’t the BOJ achieved 2 percent?
When Kuroda launched his program, oil was near $100 a barrel. In 2014, prices collapsed and later fell below $40 a barrel -- bad news in a country that imports most of its fuel and is trying to raise consumer prices. But it hasn’t been just outside factors. Kuroda’s monetary policy, along with a huge boost in government spending, was supposed to buy time for structural reforms to Japan’s economy -- including its rigid labor market -- that would stimulate growth and inflation. Actual reforms have been limited.
6. What does this mean for markets?
The BOJ’s stimulus weakened the yen dramatically and since has kept a lid on appreciation, despite some flight to safety during times of political uncertainty. The weaker yen has helped Japan’s exporters, sending corporate profits to record highs and stock prices sharply higher. All other things being equal, these trends will likely hold as long as the BOJ keeps up its stimulus. Its massive asset purchases have also had the effect of severely draining liquidity in bond markets.
The Reference Shelf
- Related QuickTakes on Abenomics and deflation.
- Interactive graphic showing what’s wrong with Japan’s economy.
- Bank of Japan statement introducing its easing policy and later explanation from BOJ on the introduction of negative interest rates and then yield-curve control.
- National Bureau of Economic Research paper on the Optimal Rate of Inflation.
- Discussion paper from the central bank on the bursting of Japan’s asset bubble.
- IMF research on the risk of deflation in the euro area and IMF Managing Director Christine Lagarde’s speech calling deflation an “ogre.”
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