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BOJ Battles Deflation

-Interview with Haruhiko Kuroda, the Governor of the Bank of Japan

In April last year, Kuroda unleashed the most intense burst of monetary stimulus Japan has ever seen. It's commonly referred to as quantitative and qualitative monetary easing or QQE. Kuroda directed the central bank to buy up huge amounts of government bonds.

He plans to drag Japan out of deflation by changing the way business leaders and consumers act. He hopes to create a cycle of growth, where rising prices for goods deliver more profits to firms. That will hopefully lead to better wages, more spending, higher prices and ultimately revive the economy.

Kuroda became governor at the bank in March last year. Previously he was vice minister for international affairs at Japan's Finance Ministry and governor of the Asian Development Bank. We asked Kuroda to give his take on the state of economy right now.

In October policymakers at the central bank surprised everyone by expanding the scale of their monetary easing. They said they were worried the shift away from deflation was faltering. That's because weak spending had persisted after the increase in the consumption tax. And also because falling crude oil prices threatened to weigh down commodity prices.

In January last year, central bank and government officials put out a statement. The bankers said they'd focus on driving inflation. Government officials promised to do their bit by putting Japan's finances in order. But Prime Minister Shinzo Abe threw that plan off course by postponing a second tax hike from 8 percent to 10 percent.

NHK Senior Commentator Akihiro Mikoda spoke with him about his policy.

Japan's economy has contracted for 2 quarters in a row. The Bank of Japan's Tankan survey last week also showed that companies were generally gloomy on the outlook. How do you assess the current economic situation? And what do you expect next year?

As you know, the Japanese economy experienced wide swing in the first half of this year. First quarter GDP growth was 6% and then in the second quarter, GDP declined by 7%. This is because of the consumption tax hike made on April this year.

Everyone expected that in the 3rd quarter, GDP growth would come back to some positive but unexpectedly, the 3rd quarter GDP figure was slight negative growth. Why the third quarter GDP growth was negative? Partly because of weak recovery of consumption, but mainly because of substantial decline of inventory investment-- meaning ongoing inventory adjustment. That is, in some sense good because after inventory adjustment is made, production would increase. So naturally many economists expect from the 4th quarter onward, the Japanese economy would show positive growth.

And actually, the recent BOJ Tankan survey showed fairly strong corporate sector, business sentiment, as well as business plan for the current fiscal year. They would increase investment and they expect a continued good profit situation. And at the same time, the household sector experiences continued increase of employment and continued increase of nominal wages.

So, I think most of economic indicators showed that the Japanese economy would recover because of underlying trend of mild, modest recovery.

Higher wages are important to create a positive economic cycle. But now, many people say prices are rising, but the inflation is not matched by wages. What do you think the policymakers can do to create an environment favorable to pay raises? What do you expect form business leaders?

Actually, in recent months, nominal wages show about 1 percent plus increase, month after month and since employment is also increasing, employment income is increasing by about 2% plus in the last, several months.

On the other hand, inflation rate, consumer price inflation excluding the direct impact of consumption tax hike, is around 1%. So, if you exclude the direct impact of consumption tax hike, real wages are increasing. But of course, consumption tax itself is a tax and for the time being, if you include consumption tax impact, real income may not show clear sign of positive increase.

But, from April next year, the direct impact of consumption tax hike on consumer price inflation would go away and employment income would continue to increase so that even if you deflate by headline inflation rate, real income, real wages, would show clear, positive sign from early next year.

The yen keeps weakening against the dollar. What's your assessment of the positive and negative effects of the weaker yen on the Japanese economy? What about such effects in a scenario where the yen becomes even weaker?

I think yen depreciation or what you might call collection of excessive appreciation after the Lehman Shock. Anyway, this yen depreciation has made, of course, corporate sector to increase export, improve profit.

On the other hand, of course, depreciation means that non-manufacturing sector, medium and small-sized enterprise, may be affected and real income of the household sector may also be affected. So, depending on sectors or depending on scale of economic activities and so on and so forth the impact of yen depreciation may be diverse in the short-run. But if yen depreciation or whatever kind of exchange rate movement is based on economic fundamentals, basically I think it would not create any problem.

From now on, how exchange rate behaves, it's difficult to predict and anyway, monetary policy is not targeted at exchange rate. Monetary policy is targeted at achieving price stability target of 2% inflation. So, I would like to refrain from making any specific comment on exchange rate movement in coming month.

Some countries are criticizing Japan's large-scale monetary easing, saying it is devaluating the yen with the aim of improving the global competitiveness of Japanese exports.

I think that, like the Federal Reserve or ECB, BOJ's monetary policy is aimed at achieving price stability target. In our case 2% and of course Federal Reserve case is also 2%. ECB is just below 2% or something. And we do not target our monetary policy to exchange rate. We do not intend to influence the exchange rates to gain competiveness and so forth. No, that is not the case and I can assure you that our monetary policy will continue to be targeted at achieving the 2% inflation rate.

Crude oil price continue to slide. If this trend continues and there is a risk that the transmission functions of the quantitative and qualitative easing is weakened, will the Central Bank make another adjustment?

I think that the recent substantial decline of oil prices, would be basically beneficial to the Japanese economy, which imports practically 100% of oil from abroad.

But at the same time, in the short run, substantial decline of oil prices would tend to exert downward pressure on consumer price inflation. That is true. But eventually in the medium to long run, decreased oil prices would raise inflation rate, consumer inflation rates, toward 2%.

So, although, when we decided to expand our QQE at the end of October, we were concerned about weak recovery of consumption, weak recovery of production, and also possibly negative impact on prices of continued oil price decline and if that situation continues, inflation expectations may be affected and wage settlement may be affected. So that we decided to significantly expand QQE and fortunately, after that inflation expectations, generally speaking, are maintained and the market responded very positively. So, I do think that oil price decline is basically beneficial to the Japanese economy.

Postponement of the second consumption tax increase. Was that unexpected?

I think many commentators were divided. Some argued that probably it would be postponed. Some others, oh no, it would not be postponed. But this is anyway, a political decision and tax policy or fiscal policy is in the responsibility of the government and the diet. So, we at the Bank of Japan just assume whatever fiscal policy or tax policy decided would be implemented.

I know that when 18th month postponement was announced by Prime Minister Abe, he at the same time could clearly stated that the medium term fiscal plan to achieve primary surplus by fiscal 2020 would not be changed, would be unchanged. So, fiscal consolidation target is not changed and also after 18th months postponement the 2% consumption tax hike would be made. And I think that these clear commitment by the government shows that they would implement necessary measures to achieve the target of the medium term fiscal plan.

The government's decision to postpone the consumption tax hike has in effect delayed the process of fiscal consolidation. So, if long term interest rates rise because of deteriorating public finances will that undercut your efforts. How do you see such risks?

I think if, I mean this is a big if, if fiscal consideration is delayed substantially and the market concern over the sustainability of the public finance then JGB interest rates might be affected. That is the sort of theoretical possibility.

But at the same time, as I said, the government continues to stick to the medium term fiscal plan to achieve the primary surplus by the fiscal 2020 and also the government declared that concrete measures to achieve the 2020 target would be fresh out by next summer and I think that is a very clear commitment to fiscal sustainability, to fiscal consolidation. So, I do not expect any serious impact on JGB prices. But, I would like to emphasize that the government is well advised to stick to the medium term fiscal plan and to achieve the primary surplus by fiscal 2020.

Japanese long term interest rates remain extremely low despite a downgrade by a credit rating agency and some economists say the large-scale bond purchases by the bank have kept some mechanisms in the bond market from functioning. Do you yourself recognize you might be destroying the market mechanism?

No, I don't think so. Of course, from the outset the QQE or the Quantitative and Qualitative Monetary Easing, intends to exert downward pressure on long-term interest rates. That has been the intermediate objective of the QQE. And actually long term interest rates have been moving downward steadily and that is the intended impact of the QQE. And of course from the outset we have been engaged in close consultation with market participants and we made some technical adjustments in our operations and so on and so forth. So I must say on the one hand, the intended impact is made. On the other hand, unintended impact like lack of liquidity in the market and volatile movement of market and that sort of unintended impact is not seen.

So, of course we will continue to monitor carefully market development. But, so far the market has responded quite smoothly and we don't think the current market conditions are what you say, unexpected or unintended or any kind of problem. I don't think so.

In the metaphor about QQE, you said the patient should continue to take medicine until the disease is completely cured but regardless of the medicine some side effects might develop if it is taken for a long period. So what do you think the side effects are of prolonged and unconventional monetary easing policy?

I think two things. One, conventional or unconventional, whatever kind of monetary policy is prolonged too long. I mean, without achieving the target and so forth may create some problem.

So unconventional or conventional, of course, under the conventional monetary policy is quite simple. Impact on short-term policy rate and short-term policy rate would affect the eventually entire financial market and so on and so forth. On the other hand, under the unconventional monetary policy, short term interest rates are basically zero. So, unless you are prepared to make them negative, conventional monetary policy tool of short-term interest rate change is lost so that some kind of quantitative or qualitative monetary easing is necessary.

So, different yes they are different but the... I don't think the program would be only in the unconventional monetary policy. Even in the conventional monetary policy, if you prolong monetary easing too long then you might experience some kind of financial market excess or something, bubble and so on and so forth.

Now, second under the QQE, we have been carefully monitoring financial market conditions whether there is any excess or not and every six months the BOJ issues the financial market report and under the latest report you can see that at this moment there is no financial excess. So we will continue to carefully monitor financial market, financial institutions carefully so that we should not jeopardize financial stability because the Bank of Japan's twin objectives are price stability and financial stability. At this stage financial stability is well maintained. Actually, Japanese financial institutions are one of the soundest among OECD countries.

On the other hand, we have not achieved price stability. We experienced long fifteen year long deflation and only in one year we achieved around 1% inflation rate, excluding consumption tax impact. But, objective, our target is 2% inflation: Consumer price increase. And we are only halfway so we are now very much focusing on price stability and we continue QQE until 2% target is met and maintained in a stable manner. In the meantime, of course we will continue carefully monitoring the financial system.

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