Monday, March 06, 2006

Financial Times: A chart for Japanese monetary policy

by Calculated Risk on 3/06/2006 07:54:00 PM

The Financial Times is free this week.

From A chart for Japanese monetary policy By Takatoshi Ito

Toshihiko Fukui, governor of the Bank of Japan, has been sending a signal through speeches and testimony ... that the time is ripe for ending quantitative easing (QE).
The BoJ considers that the self-imposed conditions for an exit from QE – positive inflation, reflected in the consumer price index ... as an actual rate ... and as a forecast – have been satisfied.

It is widely expected that the BoJ will abolish QE in April, if not as early as this week. The drive for an early termination seems to have received strong encouragement after the government’s announcement on March 3 that the inflation rate for January 2006 (compared with January 2005) was 0.5 per cent.

Last autumn, when Mr Fukui and other BoJ policy board members hinted at the exit from QE, the government sent a strong signal not to do it hastily. But in the past few weeks, Heizo Takenaka, the interior minister, Hidenao Nakagawa, chairman of the LDP policy research council, and Junichiro Koizumi, the prime minister, have all changed their tone, suggesting they may not oppose the abolition of QE.

Although terminating QE in the near term seems to have become a foregone conclusion, it is not clear why the BoJ is in such a hurry, given that the level of inflation – 0.5 per cent – is still very low. The core inflation rate, excluding energy prices as well as food, is a still more modest 0.1 per cent.

Deflation risks remain, if energy prices stop rising or if the US economy slows down later this year. ... As the end of QE nears, a future path and guidelines for monetary policy are needed.
Inflation targeting is a popular framework for answering these questions. It is now practised by a majority of central banks among advanced countries.
Adopting inflation targeting will ensure independence, which will be essential when the BoJ contemplates raising the interest rate in cases where the government opposes the move. As the policy interest rate starts to become positive, medium-term and long-term interest rates will rise.
As Mr Fukui leads the termination of QE, he should set out the direction of future monetary policy definitively, with a numerical range. By defining the BoJ’s commitment and accountability, the path forward will be cleared.