Japan doesn't need easier money; the BOJ needs easier money
By Scott Sumner
Some Bank of Japan board members have called for a debate about raising interest rates or lowering purchases of exchange-traded funds in response to the improving outlook, a summary of opinions expressed at last week’s policy meeting showed. . . .
Japan’s growth this year has exceeded some economists’ expectations, and its stock markets have rallied due to rising corporate earnings, causing some traders to question whether the BOJ should rein in its aggressive monetary easing.
“Consumer spending is doing well, supported by rising stock markets. The BOJ’s policy focus is on interest rates, so it is only natural to question its purchases of risk assets,” said Hiroshi Miyazaki, senior economist at Mitsubishi UFJ Morgan Stanley Securities.
This is the first time that I’ve seen a situation where an economy did not need easier money, but a central bank did. Japan had several decades of deflation. Even though the rate of inflation since 2012 has been quite low (about 1%/year), after a period of deflation this represents an expansionary shock, as it’s more inflation than people expected. Just as Friedman’s natural rate hypothesis predicted, the unexpectedly high inflation in Japan pushed unemployment below its natural rate. Unemployment is now 2.7%, the lowest in 23 years.
So the Japanese economy is firing on all cylinders, and does not need easier money. Nonetheless, the BOJ should adopt easier money. Why? I see two reasons:
1. Japan has set an official inflation target of 2%. As Napoleon said, if you set out to take Vienna, then take Vienna. If you are going to set an official inflation target, then you need to hit it in order to have a credible monetary policy. If policy is not credible, it will be much harder to deal with the next crisis.
2. Like most other central banks, the BOJ has foolishly decided to use interest rates as a policy instrument. If you are committed to using interest rates as a policy instrument, you need to make sure that inflation is high enough to avoid the zero bound situation. Even 2% inflation in Japan is probably not high enough to avoid the zero bound during a recession, but it’s better than 0% or 1% trend inflation.
So Japan’s in a weird situation where it doesn’t need monetary stimulus, but the BOJ should nonetheless adopt monetary stimulus. If it does not do so, Japan might fall into recession at a time when the BOJ had lost credibility. That would require lots more QE and bond buying, just what the hawks are tying to avoid. So my message to the Japanese hawks is simple. If you want to avoid a lot of monetary stimulus later, do some more monetary stimulus now, until the 2% inflation rate is well entrenched.
Even better, change the official BOJ target to NGDP level targeting.