BOJ Keeps Rates the Same

The Bank of Japan decided Thursday to keep interest rates unchanged. Where will the Japanese economy go? Will BOJ raise rates later?

Bank of Japan keeps benchmark interest rate unchanged
Mainichi Shimbun, January 18, 2007

......The central bank is independent, but political opinion has been known to influence policy in the past. Bank of Japan Gov. Toshihiko Fukui brushed off such concerns, saying the bank was only looking at economic factors, and denied a media report that the bank had informed the government of its decision in advance. "There is no change in our stance that we will gradually adjust interest rate levels depending on changes in the economy and prices," Fukui told reporters.

While it said the economy was "expanding moderately," the bank's report pointed out that both economic growth and consumer prices have fallen below its last forecast, in October, mainly because of weaker-than-expected consumption.

.......Economy Minister Hiroko Ota also sounded a cautionary note, noting that Japan was still trying to beat deflation, or falling prices, which dragged on Japan's economy for years. The nationwide core consumer price index rose 0.2 percent on year in November, the sixth monthly increase. The Bank of Japan faced similar political warnings last July -- but went ahead and raised interest rates for the first time in six years to 0.25 percent from virtually zero. Government officials repeatedly denied that the government had placed any pressure on the bank.

......Chief Cabinet Secretary Yasuhisa Shiozaki stressed the autonomy of the central bank. Politicians were just exercising "freedom of speech," he told reporters. "Various people are saying various things in their positions," Shiozaki said. "How the central bank can maintain its independence is ensured by law." But analysts warned that the perception of political meddling in monetary policy could make international investors reluctant to commit money to Japan. Still, given the recent less-than-robust price and consumption figures, he believed the bank made the right decision.

Considering low price and low consumption in Japan, the decision of BOJ is right. The problem I think most important is when the Japan will recover from a still-stagnant economy. As long as a groomy economy continues, BOJ will keep interest rates unchanged. But as Mr.Fukui said, BOJ will raise the rates if the Japanese economy recovers in the future. In this regard, it is the problem when the economy gets stronger.

What makes the economy stagnant? The low demand does. Or the low consumer's confidence does. What would stimulate the confidence? Much money supply would do.

In this point, I don't intend to imitate the Krugman's treatment for the stagnation of the Japanese economy, but I think one of the policy measures is for BOJ to supply more money into the economy until it recovers. As a macro textbook says, it will work. Now the government can't cut tax rates any longer because it has a large budget deficit and debt. In this case, if the government spends more, the people will fear the health of the budget and the future tax increase. This would be a negative effect on the economy. This situation is not hopeful. And then BOJ has no reason to do nothing. BOJ should conduct actively expansionary monetary policy to kill the deflationary pressures on the economy. Now is the time not to raise the rates.

Moreover I don't hope the government will say about whether and when BOJ should raise the rates. Many people might become doubtful about the independence of BOJ and thus the health of the financial system in Japan.