Q+A-Does Japan’s govt want to target inflation?

(For more stories on the Japanese economy, click [ID:nECONJP])

By Leika Kihara and Rie Ishiguro

TOKYO, March 5 (BestGrowthStock) – Japan’s Finance Minister Naoto
Kan has expressed a desire to target inflation as part of a
recent volley of comments aimed at pushing the central bank for
more action to drag the economy out of grinding deflation.

The government wants the central bank to do more to lift
prices, which have been falling off and on for almost a decade.

Among the most vocal cabinet critics of the Bank of Japan,
has Kan said he wants the country out of deflation by the end of
2010, much earlier than what the central bank or most analysts
see as feasible.
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For a graphic of Japanese consumer prices, click on:
http://r.reuters.com/zyv99h
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Here are some questions and answers on Japan’s inflation
target debate:

WHAT DOES THE FINANCE MINISTER WANT?

Kan hasn’t explicitly said he thinks the Bank of Japan
should adopt an inflation target. But he has given that
impression by saying several times that prices rising at an
annual rate of around 1 percent is desirable.

With Japan’s narrowest measure of consumer prices currently
falling at a record pace because of weak consumer demand, the
chance of eradicating deflation by the year-end is virtually
zero.

Kan seems to accept that such a target is a reach by saying
he was “reflecting some hope” of that goal.

So what Kan may be seeking is simply more urgency from the
Bank of Japan to deal with deflation, which can be debilitating
for an economy because consumers tend to hold off their spending
in expectation of yet lower prices.

He has protested that taking two to three years to pull out
of deflation, as the BOJ has forecast, is just too long.
Tactically, the government is raising the temperature again for
the BOJ to ensure it gets its message loud and clear.

Boosting demand is key in pushing up prices, but with
Japan’s public debt set to reach 200 percent of gross domestic
product, the government has little room for additional fiscal
stimulus.

That puts the onus on the BOJ.

WHY IS THE GOVERNMENT INCREASING PRESSURE NOW?

It needs to appear proactive about the fragile economy to
soothe voters’ concerns ahead of an upper house election
expected in July.

Support for Prime Minister Yukio Hatoyama’s government has
dropped below 40 percent in some recent surveys due to voter ire
over funding scandals and doubts about his leadership.

The rhetoric also probably relates to the budget. With a
record $1 trillion budget for 2010/11 under debate in
parliament, the government couldn’t talk about additional
spending even if it wanted to.

WHY 1 PERCENT INFLATION?

Kan wants 1 percent inflation to achieve the government’s
long-term economic growth strategy drafted in December last
year.

The government aims to achieve average nominal GDP growth of
over 3 percent and real GDP growth of more than 2 percent in the
10 years until fiscal 2020/21. For this to happen, Japan needs 1
percent inflation.

The level is also in line with the BOJ’s definition of price
stability and so will likely meet less resistance from the
central bank compared with a much higher target.

WHAT DOES THE BOJ THINK?

It is opposed to an inflation target. The BOJ believes it
already has a loose target in place. It defines long-term price
stability as consumer price inflation at or below 2 percent,
with the midpoints of most board members around 1 percent.

But it’s more a forecast than a target as the BOJ isn’t held
accountable for achieving it. The BOJ wants to keep it that way.

The last thing it wants is to be forced into setting an
inflation target and the commitment to take whatever steps
available to achieve it, such as buying more government bonds
from the market, or even directly purchasing them from the
government to finance fiscal spending.

The government, consisting of the Democrats and two small
coalition members, isn’t united on what it wants. Outspoken
banking minister Shizuka Kamei, head of a junior coalition
partner and a proponent of big spending, doesn’t think inflation
targeting would work. He wants the BOJ to underwrite debt, a
view not necessarily shared by other cabinet members. Such
action is also illegal under current Japanese fiscal law.

WHAT’S NEXT? WHAT ARE THE MARKET IMPLICATIONS?

The chance of the BOJ adopting an inflation target is very
slim. But to appease the government, it may ease policy further
to show it is dealing with deflation.

A move in March or April may be possible. The BOJ reviews
its long-term economic and price forecasts on April 30. A
revision to the forecasts will give it justification to shift
policy.

Pressure for action will continue into June, when the
government maps out a long-term fiscal discipline target and as
the upper house election, expected in July, draws closer.

The most likely next step for the BOJ will be to expand its
fund-supply operation adopted in December in reaction to the
last round of government pressure, or to increase its government
bond purchases. [ID:nTOE62100J]

WILL IT WORK? WHAT ARE THE MARKET IMPLICATIONS?

An explicit inflation target, which some central banks
elsewhere have adopted, makes a central bank fully accountable.
It would be much easier for the government to call for changes
in monetary policy if the BOJ adopted an inflation target.

But setting a target without the means to achieve it
wouldn’t be effective and could even put the BOJ’s credibility
at risk.

If the BOJ takes drastic action, such as buying more
government bonds, it may briefly push down the longer end of the
yield curve. But yields may shoot up if the move is seen by
markets as a sign the BOJ is losing its grip on monetary policy.

Investing Analysis
(Additional reporting by Linda Sieg; Editing by Neil Fullick)

Q+A-Does Japan’s govt want to target inflation?