The stalled growth in Japanese prices hasn’t just made it more difficult for the Bank of Japan to hit its 2% target inflation target, it has also made it harder for the central bank to eventually turn off the spigot to its massive monetary easing program.
While Gov. Haruhiko Kuroda has repeatedly said it’s too soon to debate any specifics of an “exit policy” to the program, former BOJ officials say Mr. Kuroda may not be able to find a way out by the time his tenure ends in April 2018.
“It seems fairly difficult,” says Miyako Suda, a former BOJ board member, given how the next increase in the consumption tax planned for April 2017 will likely interfere with the BOJ’s stated mission of “stably” attaining 2.0% inflation.
Based on the correlation between economic growth and inflation, the BOJ expects growth down the road to reduce slackness in the economy. That could lead to a situation where demand outweighs supply, putting upward pressure on prices. The government estimates demand in the economy is currently short by about annual Y12 trillion, or 2.3%, of the gross domestic product.
Kazumasa Iwata, a former BOJ deputy governor, says “lifting the inflation rate up to 2.0% could require a 5% to 7% change in the output gap, meaning it would take about five years from now on, even if the economy annually keeps growing at a pace of 2%.
He says additional stimulus would be necessary, provided that inflation expectations slide further. Making making matters more difficult, a further economic expansion isn’t as easy as they did were over the past two years.
“The BOJ’s JGB purchases are coming close to their limit, but there are a few other options left,” Mr. Iwata says.
Among the BOJ’s remaining options, buying of bonds issued by government agencies and municipal governments is still a possibility. But it’s uncertain whether the BOJ can secure securities worth as much as Y10 trillion, to match the pace of its annual monetary expansion. Other options include lowering interest rates paid on commercial banks’ excess cash deposited with the central bank and allowing interest rates to fall into negative territory like has been done in Europe. But again, it’s unclear whether it’s feasible because that “policy will mark a major shift in its policy regime,” he adds.
Ms. Suda said she objects to additional easing steps, including negative rates, as the central bank’s experiment to generate inflation by flooding the economy with trillions of yen hasn’t worked as intended.
“The experiment is over,” she says, adding that the BOJ should soon start slowing down its pace of its “excessive” asset purchases. Without such action, she warns that the continuation of the policy could cause various negative effects, including an asset bubble and disruptions in financial markets. Other potential problems: squeezing earnings at financial institutions and causing damage to the BOJ’s balance sheet that will eventually be passed on to taxpayers.
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