Unformatted text preview: credible policy tools to achieve this, setting a target would impair public confidence in economic policy as a whole. One extreme opinion was recorded as follows: negative effects on the economy and the financial system, such as damage
30. Some politicians and government officials recommended candidates for Governor who were in favour of inflation targeting to the Prime Ministers Office. In Governor Hayamis press conference on 24 January 2003, a reporter asked the Governor for his view on inflation targeting, from the background of the political movement that the support for inflation targeting should be a prerequisite for the next Governor. In his reply, Governor Hayami branded inflation targeting as a reckless bet, which might make the economy extremely unstable and have side effects and risk. He emphasised that the Bank had expanded the monetary base and taken other actions, and was confident that the economy would recover from deflation without such a bet (available only in Japanese at <http://www.boj.or.jp/press/04/press_f.htm>). 246 Takatoshi Ito to the credibility of economic policy and to financial markets, would exceed the positive effects (MPM of 10 October 2002). The Bank of Japan successfully lobbied politicians sympathetic to the Banks view to have the previous Deputy Governor, Mr Fukui, who was in the private sector and not voicing any opinions on monetary policy at the time, appointed as the new Governor.31 One possibility is that the Bank of Japan, using the term of Cargill et al (2000), fell into an independence trap. According to these authors, the Bank of Japan was afraid to take bold actions after it had just gained independence. Theoretically, flexible adjustments and bold actions were supposed to have become possible under independence, since actions were at the sole discretion of the Bank Board. On the contrary, the Bank became much more conservative and rigid in taking actions, especially unprecedented ones. They feared that action might be judged a failure later and damage credibility. If this is the case, the Bank of Japan was given independence precisely at the wrong moment because the economy called for unprecedented monetary policy actions. 3.4 The economics of the pros and cons of inflation targeting As documented above, and in more detail in the Appendix, most Board members, including Governor Hayami and Deputy Governor Yamaguchi, as well as staff economists at the Bank of Japan, opposed inflation targeting. The arguments against inflation targeting, mostly presented during the Hayami period, will be presented and discussed here. The specific arguments have shifted somewhat over time, but the following seems to be a complete list. Rebuttals from advocates of inflation targeting are also considered.32 3.4.1 Reflation policy is bad, and the inflation rate cannot be controlled
In the early stage of arguments for inflation targeting, the Bank of Japan contended that inflation was not a solution to Japans economic problems, and policies to raise the inflation rate may end up achieving a very high inflation rate, even if the aim is a moderate inflation rate. The reasons why moderate inflation was regarded as impossible seem to be two-fold: (1) it was technically impossible; and (2), it was politically irresistible. One of the early criticisms of inflation targeting was a reaction to the proposal from Krugman (1998) of 4 per cent inflation for 15 years. Inflation targeting was characterised as a simple-minded reflation policy and thus rejected. As it came to be understood that inflation targeting is a flexible framework for monetary policy
31. See Fujii (2004, p 283) for an account of the lobbying. 32. The list is compiled predominantly from MPM discussions, summarised in the Appendix, but also press interviews, speeches and articles of the Governor, Deputy Governors, Board members, and staff economists. For the Bank economists views on related issues see, for example, Okina (1999a, 1999b), Fujiki, Okina and Shiratsuka (2001), Okina and Shiratsuka (2002, 2004), and Okina, Shirakawa and Shiratsuka (2001). Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting? 247 and that the most likely target range would be somewhere between 1 and 3 per cent, this particular criticism disappeared. Governor Hayami (2000a) categorised inflation-targeting proposals in two ways: an inflation policy, as advocated by Krugman, of aiming at 4 to 5 per cent; and, a variation of inflation policy, tolerating a moderate inflation rate of 2 to 3 per cent. He assessed the latter policy as follows:
it may vitalize economic activity. However, given the current situation in Japan where prices are almost level, such a proposal is tantamount to artificially creating inflation. Furthermore, to implement such a proposal, many have suggested that the Bank of Japan should increase its outright purchase of government bonds or underwrite them. Some even advocate that the Bank of Japan should purchase stock...
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