Bank of Japan policy board member Seiji Nakamura rebuffed government pressure for more BOJ action to fight deflation, saying that pumping liquidity into the financial system alone will not put an end to debilitating price falls.
The heavily indebted government fears deflation and a strong yen could push Japan back into recession in the run-up to upper house elections. Analysts say it may urge the central bank to buy more government debt or expand a funding operation it introduced in December to prevent that.
Nakamura suggested the bank wasn’t likely to oblige by increasing its debt buying, however, warning the government that it needs to get to grips with its fiscal problems.
“The economic recovery has shed light on fiscal discipline,” he told a news conference after giving a speech to business leaders in Fukuoka in southwest Japan.
“It would be a grave issue if yields rose because of a risk premium or investor fears over the risk of holding government bonds. The government needs to tackle the issue before the markets start moving,” he said.
The prime minister and finance minister have been calling on the central bank to do more to help ease deflation, but they haven’t said exactly what steps they want the BOJ to take.
“Nakamura is resisting government pressure and asserting the BOJ’s independence,” said David Cohen, director of Asian economic forecasting at Action Economics in Singapore.
“The BOJ tried quantitative easing a few years ago and didn’t enjoy much success. This also highlights its impotence.”
The BOJ is reluctant to ease monetary policy further partly because it expects the pace of falls in prices to ease gradually. Last week it said deflation would be milder than it previously forecast in the fiscal year from April and the following year.
Pushing back
Nakamura said the fight against deflation, where price falls and weak demand feed into each other as buyers wait for prices to slip even further, must be shared.
“In order to solve demand shortages, it is important for the BOJ, the government and private sector firms each to play their own role,” he told business leaders.
He stressed the need for innovation in the private sector for creating demand, but offered few other clues on what fiscal or monetary policy options there were to get prices rising.
For its part, the government, whose support rate is slipping ahead of upper house elections due in summer, has little room to lift demand by spending more as the national debt is already nearing 200 percent of GDP.
Standard & Poor’s last month cut the outlook on Japan’s AA debt rating to negative, saying the policy bind could lead to a downgrade unless measures were taken to stem fiscal and deflationary pressure.
“It is natural for central bank policymakers to call for fiscal reconstruction when debate about exit strategies globally is focusing more on fiscal issues than monetary policy,” said Masamichi Adachi, senior economist at JPMorgan Securities Japan.
The BOJ is virtually alone in expanding monetary easing. The Federal Reserve and the European Central Bank have said they will start phasing out their emergency lending and liquidity facilities in light of improvements in credit markets.
“The government and the BOJ need to talk to each other more about the fiscal problem, but that hasn’t happened in Japan so far,” Adachi said.
The Japanese economy started to recover from the second quarter of last year and it is expected to post fairly robust growth for the fourth quarter.
But Nakamura said the downside risks were still larger than those on the upside and that the bank won’t rule out any policy options in responding to economic conditions ahead.
Most economists think the economy will slow down in the first half of 2010 and, as the recovery is driven mostly by strong exports to Asia, it could be hurt by any further rise in the yen.
Nakamura said strong demand in Asia may cause Japanese firms to shift production abroad, thus limiting a recovery in domestic capital spending and jobs even as the overseas economy recovers.
