Inflation Targeting: No Magic Bullet

Richard Katz (The Oriental Economic Report)

This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on February 6, 2003: posted here with the author's permission.

The following oped on "Inflation Targeting" and the new BOJ governor appeared in the Feb. 5 Asia Wall Street Journal. You must be a subscriber to be able to read it.
http://online.wsj.com/article/0,,SB1044394105945603093,00.html

The gist is:

1) There's a lot of pressure on Koizumi to appoint a new Bank of Japan governor committed to "inflation targeting." However, in the last week or two, both Koizumi and Takenaka have backed off on past endorsements of inflation targeting. The market has read this as upping the odds that former senior BOJ official Toshihiko Fukui will replace Hayami. If so, the basic BOJ approach will remain the same, but the execution and, especially, communication may improve. Keep in mind that Koizumi likes surprises.

2) Inflation targeting won't stimulate recovery of demand no more than did quantitative easing. Deflation is not the cause of Japan's weak demand but a symptom.

3) Even if inflation were the solution, by itself, the BOJ cannot revive inflation. So, even if someone like Nakahara were appointed to replace Hayami, don't expect that to produce significant changes in inflation. While the bond markets might react in the near term to such an appointment, as long as the BOJ keeps up its monetary flood, that will continue to keep longterm rates down for some time to come.

4) While many respected economists sincerely believe inflation targeting will help, its most fervent proponents in Japan are the opponents of reform. They want to use inflation to raise the price of stocks and real estate used as collateral for loans. That, they hope, will obviate the need for real restructuring at chronic money-losing borrowers.