Further Comment on Peter Tasker’s Response

Richard Katz (The Oriental Economic Report)

This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on February 10, 2003: posted here with the author's permission.

Peter Tasker, in my view, misses the key point about Takenaka. Unlike many others in the LDP and MOF, he is not proposing inflation targeting in particular--or monetary ease in general--as a substitute for economic reform. He correctly sees monetary ease as a partner of reform.

At one point, Takenaka even stated, "Unless banks make progress on bad-debt disposal, the monetary easing by the Bank of Japan will not produce results, making it impossible to beat deflation." Similarly, U.S. Treasury Undersecretary John Taylor told a Tokyo audience, "Neither monetary policy nor banking policy can fully succeed without the other in achieving the goals of strong economic growth."

That is exactly the BOJ's point of view. The BOJ has repeatedly stated that it will provide all the monetary fuel that Japan needs. In fact, it is already doing so. But, the BOJ adds, monetary stimulus can never be a substitute for structural reform, beginning with a clean-up of the nonperforming loans.

Saying that Japan needs monetary ease (along with fiscal stimulus) is like saying a car needs gasoline to run. True--but the car could also use an engine. The engine is structural reform.

As for Nonaka, while he opposes the particular tactic of inflation targeting, he has long been a vociferous critic of the BOJ for being too tight.

In my own view, inflation targeting doesn't add anything to the extensive monetary stimulus already undertaken by the BOJ. If you've already filled the gas tank on a car with no engine, it's hard to see how announcing a target of 30 miles an hour, or 60, or 90, makes a difference in how fast the car will actually go.

Those economists who claim that inflation targeting will solve the problem have no better track record than those economists who used to claim that building "bridges to nowhere" would solve the problem.

Years ago, proponents of monetary magic bullets claimed that pushing interest rates to the floor would cure Japan. Four long years ago, the BOJ began the zero interest rate policy. Then, they claimed that "quantitative easing" would do the trick. Again, the BOJ complied--with no better results. The BOJ expanded the so-called monetary base at record rates. But the broader money supply barely responded. Bank loans kept falling and so did prices.

The fact is: the BOJ has already announced an inflation target. A few years back it said it would keep printing lots of money until inflation returned to something above zero. That has clearly failed to work. Why would the tactic be any more successful just because the BOJ raises the target to 3%? I would not be surprised if eventually the BOJ succumbs to political pressure and does raise the target. When that also fails, the BOJ critics will find a new excuse.

Economists disagree on the relationship between monetary stimulus and reform. Some, like Takenaka, see them as partners. Some, like Paul Krugman, stress monetary stimulus and openly oppose reform, saying that it would be too depressive.

But Diet members, bankers and borrowers are hardly known for studying debates among academic economists. Why then has inflation targeting become such a salient political issue among these groups? I think it's because they see it enabling them to avoid painful reforms. Just after Koizumi became LDP President, a Dietman in the Hashimoto faction told me now all of the LDP was for reform. What is reform, I asked him. His answer: the BOJ will print lots of money, which will raise the Nikkei index to 20,000. That will allow the banks to write off all the NPLs without forcing firms into bankruptcy. The NPL problem will be gone and Japan will grow again.