BOJ should create inflation to fight deflation

From the Asahi Shimbun, 17 October 2002.

Following are excerpts from an Asahi Shimbun interview with Iwata:

Q: What are some of the factors driving down stock prices?

A: The main reason is deflation, meaning continuous declines in consumer prices and asset prices (stock and land prices). Media reports blame delays in bad-debt disposal by banks. But that is based on misunderstandings.

Bad-debt disposal means paring down loans and driving (deadbeat) clients into bankruptcy. As a result, deflation gets worse, creating more bad loans. So the Bank of Japan must make a bold change in its monetary policy. That's the only way to stop deflation.

Q: Money is extremely cheap, with interest rates close to zero. How do you view this situation?

A: That's not enough. It's necessary to set an inflation target so consumer prices can rise 1 to 3 percent in the next 12 months. To achieve that target the BOJ should increase its purchases of long-term government bonds from banks and supply plenty of cash to the financial market. The BOJ should also buy foreign currency-denominated government bonds so the yen rate can go down.

Q: Still, it won't be easy to bring about inflation, will it?

A: If the BOJ supplies more cash to the market, more money will go into stocks and foreign-currency bonds and also into real estate. As a result, asset prices will go up, creating inflationary expectations.

If stock and other asset prices go up, assets held by business will appreciate, creating incentives for investment. For banks, such businesses will become more attractive borrowers. So things will begin to improve on a broad front.

Q: Don't you think unrestrained bond purchases will undermine fiscal discipline?

A: The Koizumi administration is putting a 30-trillion-yen cap on annual bond issuance. The BOJ should get a government agreement that bond issues will be restricted while it is fighting deflation. To create inflationary expectations, the central bank must take drastic action such as buying up government bonds held by banks.

Q: Inflation can produce very bad effects as well. Is it possible to limit it within reasonable bounds?

A: Opponents of inflation exaggerate its negative side. Negative effects can be contained by setting limits on the inflation rate. At present there is so much excess employment and capacity that supply exceeds demand by a wide margin. So high inflation is out of the question.

Central banks in other countries are setting inflation targets of 2 or 3 percent, but no problems have presented themselves. The BOJ says it will continue monetary easing until consumer prices start going back up. But it sets no time frame for that, so its policy responsibility is vague. Given continuing deflation, it is little use maintaining the current level of monetary easing. Kikuo Iwata, 59, specializes in financial theories and urban economics. He is the author of "The Economics of Financial Policy," "The Economics of Zero Interest Rates" and other books.