Yoshihide Suga’s first big decision as Japan’s new prime minister is deciding what directive to give the central bank.
To be sure, Suga’s to-do list is long and daunting. It includes who gets the plum cabinet jobs, which world leader gets his first phone call and which foreign capital to visit first. But as the economy sputters, no question looms larger than how hands-on he will be with the Bank of Japan.
If two news items on Sunday are any guide, Suga is likely to micromanage BOJ policies even more than Shinzo Abe did.
One was fresh evidence that the nation’s biggest manufacturers are pessimistic for a 14th straight month, dashing hopes for even the mildest of recoveries for the Covid-19-stricken economy. The other was Suga saying he’ll set no limit on how many bonds his government issues to end the recession.
In other words, expect BOJ Governor Haruhiko Kuroda’s team to smooth out the process and hold international credit rating companies at bay. And expect, in the process, for the BOJ to lose whatever semblance of independence it retains.
The obedient bank
Granted, BOJ autonomy has long been more of a kabuki performance than a quantifiable arrangement. Some quick history: The central bank only won legal independence for the first time in 1998.
Previously, the BOJ stuck to the charter written in 1942 and based on the Reichsbank of Nazi Germany, enacted at the height of World War II. That had replaced the earlier Bank of Japan Act dating back to 1882.
Though a new model was debated time and time again, it didn’t get formally changed until the aftermath of the 1997-1998 Asian financial crisis. The new law handed the BOJ a “price stability” mandate not unlike that of the US Federal Reserve. The BOJ also had wiggle room for policymakers to support job growth.
Too much, it turned out.
The BOJ “has often faced trade-offs between guns and butter, stability and growth, the threat of economic backlash and the moral hazard problem,” says economist Masato Shizume of Waseda University. “The bank has been and still is learning from new challenges.”
Three years after winning independence, the BOJ found itself dealing with an imploding economy. The cause: a bad-loan crisis that elected officials failed to address. Rather than upset vested interests, politicians pressured the BOJ to support the economy. It included a very public effort to shame BOJ policymakers.
The result? Quantitative easing.
After the first QE burst, a succession of governments demanded the BOJ do more. Enter Prime Minister Shinzo Abe, who in 2012 threatened to revise laws guaranteeing BOJ independence. Abe’s planned amendments to the BOJ Law would empower the government to layer new responsibilities on to the BOJ.
Up until that point, the government was barred from sacking the BOJ governor or senior board members. The BOJ got the point, though. It bought Abe’s silence with a monetary onslaught the likes of which world markets had never seen. By March 2013, Abe had a new BOJ leader in the job, Haruhiko Kuroda, to push into even more uncharted territory. And a new 2% inflation target.
The end product, though, is that it’s now become even less possible to see where the Ministry of Finance ends and the BOJ begins than before 1998.
“Weaknesses with regard to the personal independence of the BOJ and factors pertaining to Japan’s political economy seem to continue to render the bank prone to political interference,” argues Moritz Bälz, a Japan expert at Frankfurt’s Johann Wolfgang Goethe University.
That interference may be about to intensify as Suga looks at the troubled economy he inherits as Covid-19 fallout intensifies.
For all the kudos being heaped Abe’s way, it’s important to recognize that gross domestic product is now back to 2012 levels – ie levels dating back to before his tenure. After nearly eight years of “reflating” the economy, wages and consumer prices are largely flat.
Abe relied too much on aggressive BOJ easing to stabilize growth and not enough on the structural reforms needed to jolt Japan’s corporate sector into new life.
So, here Japan is in 2020, with monetary and fiscal functions at in a state of symbiosis that will be hard to separate again.
Ben Bernanke saw this coming. Bernanke’s pre-Fed-chairman claim to fame was his extensive autopsies of Japan’s banking crisis and its subsequent “lost decade.” In 2003, while he was a Fed policy board member, Bernanke gave speech in Tokyo, where he warned “the role of an independent central bank is different in inflationary and deflationary environments.”
In the face of inflation, Bernanke said, central banks can say “no” to the Ministry of Finance. Yet “with protracted deflation,” he warned, “a more cooperative stance on the part of the central bank may be called for.”
Five years later, Fed Governor Bernanke would get a taste of this very dilemma. Under his leadership, the Fed also went the QE route. Yet the BOJ’s challenges under a Suga government could be unprecedented.
For one thing, Abe has already tossed a whopping $2.2 trillion of rescue stimulus at a coronavirus-traumatized economy. It has had little effect. The latest Reuters Tankan survey of 485 large and mid-sized companies more than bears that out.
How much more to spend?
Granted, the cupboard isn’t quite bare, as Suga made clear Sunday. And at an evening press conference on Monday, hours after he had won the party headship, Suga pledged even more stimulus.
But with a debt-to-GDP ratio of about 250% that will some require some serious policy finessing.
“Only when we have economic growth can we push through fiscal reform,” Suga said on Sunday. “What’s most important is to create jobs and protect businesses.” When asked if there was a limit to bond issuance: “I don’t think so. What’s important now is to improve current [economic] conditions.”
Will international rating companies be forgiving?
In late July, Fitch Ratings cut the outlook for Tokyo’s sovereign debt to negative from stable as Covid-19 shoulder-checked Asia’s second-biggest economy. At the time, it warned that “sharply wider fiscal deficits in 2020 and 2021, as we project, will add significantly to the country’s public debt, which even before the pandemic was the highest among Fitch-rated sovereigns as a share of GDP.”
Fitch analyst Stephen Schwartz says he “anticipates that an emphasis on returning the debt trajectory to a sustainable path will remain a core policy goal in a post-Abe administration.”
That might only be possible if the BOJ continues to increase its already aggressive government bond purchases.
For now, the BOJ is likely to avoid outright debt monetization of the kind it tried in the 1930s (read more on that here). That had the BOJ buying public debt directly from the Ministry of Finance to manipulate interest rates lower.
Today, Kuroda’s BOJ would be mopping up fresh government borrowing in the secondary market to avoid a spike in debt yields.
In doing so, though, the BOJ would be hanging over the last vestiges of its autonomy to Suga’s Ministry of Finance. The 2% inflation target Team Abe forced on the BOJ in 2013 was encroachment enough, many observers agree.
At the time, Jens Weidmann, president of Germany’s Bundesbank, said threats to BOJ independence were among the most “alarming attacks” he’d ever seen on central banking. “A consequence, whether intended or not, could be the increasing politicization of the exchange rate,” he added.
Opinion is divided. Count Adam Posen, economist at the Peterson Institute for International Economics, among those who think the end justifies the means.
“Certainly, there has been active coordination of the BOJ with the expansionary fiscal policy by the Japanese government, particularly since early 2013 – and this has been a success for the real side of the economy,” Posen argues. “It has done so without causing strong inflationary pressures, which is both frustrating narrowly and helpful overall.”
Such coordination, Posen says, “has enormous advantages in that it is credible, it is achievable, it is transparent. While the central bank is enabling fiscal policy, it is in no way having the central bank judge fiscal policy. Yield curve control is not in any way conditional on the specific measures of the fiscal policy or the allocation of it. And for an independent central bank, it is always credible that they can stop at any time.”
But – and it is a big “but” – can the BOJ stop at any time?
This is the question with which Kuroda and his team must now grapple. On Sunday, Suga seemed to be channeling Mario Draghi, the then-European Central Bank whose famous 2012 “whatever it takes” preparedness pledge became a mantra or sorts for monetary activism.
“Japan’s GDP suffered its biggest postwar contraction in the second quarter, so we need to do whatever it takes to support growth,” Suga said. “We have reserves set aside, so we can of course tap those. But if additional steps are necessary, we would act.”
By “reserves,” Suga doesn’t mean Tokyo’s $1.32 trillion foreign exchange stockpile. He means additional fiscal firepower Tokyo can deploy to support growth.
And that, by extension, means a BOJ getting offers to buy ever more government issuances that it can’t refuse. And a further mudding of an already murky BOJ-government matrix.