In the end, Toshihiko Fukui didn't cave. After weeks of not-so-subtle pressure from Prime Minister Junichiro Koizumi's government to keep Japan's five-year run of ultra-easy money in place, the Bank of Japan's governor signaled the party is over. On Mar. 9, the BoJ's policy board voted to slash the flood of excess cash available to Japan's giant banks over the next few months. The bank also introduced a rough inflation target of 2%, and set the stage for a series of modest interest-rate hikes from today's near-zero levels -- though most economists believe that won't start until late this year.
For an economy that grew at a blistering 5.5% annualized rate in the fourth quarter of 2005 and should hit 3% or so in 2006, this would seem like an eminently sensible thing to do. Japan's once-rickety banking system has had its health restored. The grinding price-deflation that eroded corporate earnings back in the late 1990s has abated. The benchmark Nikkei stock index, which finished up 2.6% on the BoJ news, has been rocking the better part of a year now. And corporate Japan's balance sheets are at their strongest levels since the late 1950s.
HARDLY HARSH. True, to keep the world's second-largest economy on track, the BoJ will need to take extreme care with the timing of its interest-rate hikes. If it progresses too slowly, the central bank could see inflation take hold. But if it moves too aggressively, quickly pushing interest rates back up to 3% to 4%, Japan's expansion could find itself cut short. Getting that right will make for a very tough policy call (see BW Online, 3/6/06, "Tough Rate Calls at the Fed, ECB, and BoJ").
But the real import of the BoJ move isn't necessarily its immediate economic impact. The planned reduction in excess cash made available to the banking system may sound Draconian, but it really isn't. It's coming down from extremely high levels, and the banks and the robustly profitable Japanese corporate sector don't really need the surplus yen.
More important is the strong signal the bank sent to Koizumi and the global markets: When it comes to setting monetary policy and guaranteeing price stability, the bank will call them as it sees them.
BOON FOR LITTLE PEOPLE. It's worth remembering that the BoJ has been truly independent only since 1998. Before that, the Japanese central bank often followed the wishes of prime ministers and the elders of the long-dominant Liberal Democratic Party. For decades, central bank governors got their jobs because of political loyalty rather than monetary smarts. Policy-board meetings often amounted to a sham, with the board merely rubber-stamping the wishes of its political masters.
This matters if you consider the enormous power a central bank has over the price of money -- and hence the purchasing power of ordinary Japanese. Past officials like Kakuei Tanaka treated the BoJ as a plaything, with disastrous effect. A former construction executive, Tanaka strong-armed the BoJ in the early 1970s to keep money cheap in order to fund a massive public-works program on the Japanese archipelago just as energy prices skyrocketed. The result: Inflation surged as high as 24% in 1974.
In the late 1980s, the BoJ's image took another savage beating. The bank bowed to political pressure to keep interest rates low to help take the sting out of a rising yen while the Nikkei and land prices vaulted to unsustainable levels. The result: one of the biggest economic bubbles in post-war history. That ended in an inevitable collapse, and ushered in a decade of economic stagnation in the Land of the Rising Sun.
KOIZUMI'S DEFICITS. The Japanese Diet finally granted the BoJ independence in 1998 -- and the political meddling in the serious business of setting monetary policy was supposed to have ended. Well, someone forgot to tell the Prime Minister and his economic team. They baldly threatened to dissolve the BoJ's legislative charter and place it back under government control if the central bank didn't play ball. And they shamelessly pressured Fukui, arguing that the economic recovery was far too fragile to start fiddling with credit policies.
Nonsense: The real threat to the economy comes from the outsized budget deficits Koizumi and his LDP predecessors have tolerated over the past decade. Japan's government IOUs now clock about 150% of gross domestic product, the highest in the industrialized world. The LDP wants to keep long-term interest rates low so the government can roll over that debt and issue new bonds at dirt-cheap rates.
Well, the BoJ didn't blink. That's a wise move, given the importance of the BoJ developing street cred with the global markets. If it acts like a shill for the government, its policies will end up compromised.
SERVANT NO MORE. The shift also marks something of a victory for ordinary Japanese savers. While cheap credit has served as a boon to corporate borrowers, Japan's super-saving citizenry has been getting fleeced. A huge chunk of Japanese savings exists in the form of bank deposits, which have yielded next to nothing for a decade. When the BoJ gets around to normalizing interest rates again, that will provide some relief for millions of Japanese families and retirees who rely heavily on savings to fund retirement.
The BoJ proved on Mar. 9 that it no longer will function as the government's doormat. When it comes to something as crucial as setting monetary policy, this is a beautiful thing for Japan.
Bremner is the Asia Regional editor for BusinessWeek in Hong Kong
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