Ito and hayashi 2004 argued for the desirability of

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Unformatted text preview: target range, such as a 1 to 3 per cent CPI inflation rate, and that the Bank also announce its willingness to adopt policy to achieve the target in the medium run, say in two years. The positive inflation target is consistent with the legal mandate of price stability, because: (1) the price index has an upward bias; (2) having a buffer to zero is important given that a combination of deflation and a zero bound interest rate is a serious problem; and (3) a positive inflation rate makes it easier to realise necessary relative price and relative wage adjustments (recall the Akerlof et al argument). 3.2 Why the Bank of Japan should have adopted inflation targeting The arguments of inflation targeting advocates in Japan can be summarised as follows. (1) Accountability and transparency. Since the Bank of Japan became legally independent in April 1998, it has needed to be accountable for its actions. The mandate was clearly price stability, as mentioned in Article 2. But without a concrete definition of price stability, it is hard to assess whether the Bank has acted appropriately. A numerical target either a point with a tolerance band around it like the United Kingdom or a range like New Zealand would help to clarify the meaning of price stability. Once a target, either a point or a range, is clarified, policy actions can be easily explained, in the context of trying to achieve the target in the medium run. Actions become transparent, and communication with the market becomes easier. (2) Instrument independence. If and when the Bank of Japan commits to the specific goal of an inflation target, how to achieve it should be completely left to the Bank. This is called instrument independence. As the Bank will be accountable for the consequences of its actions, the government would not need to pressure the Bank on specific policy measures. The Bank would also not have to respond to criticism or pressure and would not need to become so defensive about critics arguments on what kind of policy actions should be taken. In other words, a situation like September 1999 would be avoided, or even if pressure comes, the Bank could divorce itself from the controversy. Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting? 243 (3) Impacts on inflation expectation. The fundamental problem faced by the Japanese economy since the mid 1990s (recall Section 1) has been a cyclical problem of deflation, combined with the interaction between deflationary expectations and the zero interest rate bound. The more pessimistic outlook on deflation meant higher real interest rates and depressed economic activity. Available policy tools, monetary and fiscal, are limited, and the best bet for breaking deflationary expectations is to adopt and commit to a target with a positive inflation rate. Combined with adopting unconventional monetary policy, an inflation target will also help influence the publics expectations. It may not have an immediate, tangible impact on inflation expectations, but with continued reference to it and policy measures implemented to achieve it, the impact would become stronger. The UK experience shows that the combination of independence and an inflation target would be a powerful weapon to stabilise inflation expectations at around the target inflation rate.29 3.3 Political economy of why the Bank of Japan did not adopt inflation targeting According to the minutes of the MPM discussions (disclosed about one month after the meeting), inflation targeting was sometimes discussed quite intensively, but, in general, there was an intermittent level of interest. In order to quantify the interest of the Board in inflation targeting I have counted the number of times inflation target[ing] or target of inflation rate was mentioned in the recorded minutes for the period of 26 March 1998 to June 2004. Figure 5 shows the number for each MPM discussion. The minutes from March 1998 highlight the waves of interest in inflation targeting. A detailed examination of each MPM when inflation targeting was significantly discussed and my comments on the discussion are in the Appendix. The first wave was from mid 1999 to the spring of 2000. At this stage, Mr Nobuyuki Nakahara, a Board member, consistently proposed adopting inflation targeting, but was always voted down by 1 to 8 votes. According to discussions at the MPMs and speeches of Board members, the majority of the Board held the following view: deflation was not that undesirable as long as it reflected technological innovation and cheap imports. Moreover, when technological innovation puts downward pressure on prices, it is difficult to select an appropriate price index and to define price stability, let alone the numerical target of inflation. However, there was growing pressure from the academic community for the Bank to adopt inflation targeting. According to the minutes of various meetings, the majority of Board members remained sceptical about the merits of adopting inflation targeting. But the increasing interest in inflation targeting inside and outside the Bank led to the decisio...
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