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The Bank of Japan is about to unveil its new identity. Under intense pressure from new Prime Minister Shinzo Abe, the central bank is preparing to reinvent itself as a no-holds-barred monetary warrior. Whether the BoJ can slip convincingly into the role of a deflation-slaying Ninja will depend a lot on its battle plan.
To be successful, the BoJ will need to sneak into the minds of consumers, savers, employers, investors and bankers to dispel the now-ingrained expectation that incomes, prices and assets will keep declining. Not all the strategies the BoJ can employ to aim for two per cent inflation - a target its policy board is likely to adopt at its January 21-22 meeting — will be equally effective. We assess the weapons in its arsenal, and award them a “Ninja quotient” according to how lethal they are.
Option 1: More of the same
Ninja quotient: 3/10
The most conventional option is for the BOJ to beef up its 101 trillion yen ($1.1 trillion) asset-purchase programme. It could also tweak the plan by buying longer-dated bonds, or extend the programme beyond its scheduled expiry date at the end of 2013.
The biggest benefit will be a temporarily weaker yen. But printing more money to buy more assets may not, by itself, be inflationary. That’s because the private sector will continue to believe the boost in the money supply is temporary, and refuse to spend.
Option 2: Open-ended easing
Ninja quotient: 5/10
One idea under serious consideration is for the BOJ to promise to keep buying assets as long as inflation expectations do not exceed a pre-specified level. For example, it could commit not to start shrinking its asset-purchase programme until policy makers’ forecast of future inflation exceeded 3 percent - levels the country has not seen since 1991. That would give the private sector greater assurance that monetary easing won’t be unwound in the foreseeable future. The US Federal Reserve has tied future interest-rate decisions to inflation and unemployment. The BOJ could be even bolder.
Option 3: Buy foreign securities
Ninja quotient: 7/10
All the assets the BOJ has purchased, including government and corporate bonds, exchange-traded funds and real-estate investment trusts, are yen-denominated. But the cash the BOJ has pumped out to buy these securities remains largely unused because of a lack of private credit demand. Buying foreign-currency securities using newly printed yen could boost Japan’s output, wages and prices by driving down the currency. But the BOJ doesn’t have the legal authority to intervene in the currency market. To make such a plan work, the finance ministry and the BOJ would have to work together. If the yen drops like a stone, any such gambit could become diplomatically indefensible.
Option 4: Scrap interest on excess reserves
Ninja quotient: 9/10
At the moment, banks that keep idle funds parked at the BOJ pocket the central bank’s 0.1 percent interest rate on excess reserves. That payment, which is greater than the yield on two-year bonds, offers banks a big incentive to carry on hoarding cash. Lowering the rate to zero might encourage lenders to deploy funds in riskier credit (helping small companies), longer-duration government bonds (helping the government) or foreign assets (helping the economy by weakening the yen). The risk is that Japanese banks will suffer large losses, but it may be worth a try.
Even before the BOJ unveils its choice of weapon, markets have been stirring. Expectations of inflation, as measured by the difference in yield between conventional and inflation-linked five-year government bonds, have widened from 0.53 percent in August to 0.83 percent today. Yet there is still substantial uncertainty about whether the central bank will be able to deliver 2 percent inflation.
If none of its weapons succeed, even more extreme measures may be needed. One highly radical option would be for the BOJ to ban the use of the physical currency altogether, forcing idle surpluses into the real economy. Prices would shoot up, perhaps uncontrollably. Such a drastic weapon is not on the table - at least not for now.