Feb 21, 2005

Finance Minister and BoJ Clash over Monetary Policy

From the FT,

In testimony to the parliamentary budget committee, Sadakazu Tanigaki, finance minister, said: "If [nominal] interest rates are pulled up now, even by a little, that will cause real interest rates to climb. The Japanese economy can't tolerate that now." Mr Tanigaki said zero rates, though they had unpleasant side effects, had been "underpinning the economy".

Paul Sheard, economist at Lehman Brothers in Tokyo, said Mr Tanigaki's warning about the dangers of premature tightening was a "polite wake up call" to the BoJ. He said talk of tightening either monetary or fiscal policy at a time when the economy had stalled was wrong-headed.

Speculation that the BoJ is preparing to tighten its quantitative easing policy, introduced in March 2001, has risen following the release of minutes showing that two policy board members in December proposed lowering the bank's liquidity target.

Last week, the BoJ left that target unchanged at Y30,000bn-Y35,000bn (US$286bn- $333bn) but analysts will scrutinise minutes of January's policy board meeting, due to be released on Tuesday, to see whether support for lowering the liquidity target has hardened.

Although the BoJ is committed to keeping zero interest rates in place as long as deflation persists, any lowering of the liquidity target would be interpreted by the markets as an prelude to tightening.

How the BoJ reacts to signs of inflation will hopefully be determined by the response of Japanese consumers to inflation. I expect inflation will stimulate the economy making rate hikes and tighter liquidity possible without causing harm to the recovery. This is not an urgent decision though so current policies should be in place another 3-4 months to see how things develop.

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