If the rising decibel level of the voices is any guide, the Bank of Japan (BoJ) is preparing to engi...
If the rising decibel level of the voices is any guide, the Bank of Japan (BoJ) is preparing to engineer a small increase in interest rates at its policy meeting this week.
What's the rush? To be sure, some of the economic data has been looking up. The Japanese economy expanded at an annualised 10% rate in the first quarter after a two-quarter contraction; surely no-one believes that double-digit growth is an emerging trend.
The closely watched Tankan survey, a quarterly poll of business sentiment released last week, showed improved business conditions among large manufacturers in the second quarter. In fact, the index registered its first positive reading in almost three years.
Still, anyone who believes that stabilisation in the financial system is a necessary condition for issuing Japan a clean bill of health will be unconvinced that the time is right for an end to its near-zero interest-rate policy. Judging by its vital signs, Japan's banking system is nowhere near functional. Bank lending has been contracting on a year-over-year basis for almost four years. Growth in Japan's broad money supply, M2+CDs, has decelerated dramatically in the past year, from a year-over-year 4.3% increase last June to 1.9% now. These are not the signs of a financial system that can support an economic expansion.
If we learned anything from the Great Depression in the US in the 1930s and the savings and loan crisis in the late 1980s and early 1990s, it's that when your banking system isn't functioning, your economy is down for the count.
BoJ Governor Masaru Hayami had set two preconditions for abandoning Zirp. One was signs of a self-sustaining economic recovery, which, if one quarter suffices as an adequate observation, satisfies his terms. In the first quarter of 2000, the contribution to GDP growth came entirely from the private sector.
The second precondition was an end to deflation. Where's the evidence of that? Japan's consumer price index fell 0.7% in May from a year earlier. In only a handful of months in the last 13 years - all of them within the last six months - has deflation been worse.
Like the Federal Reserve in the 1930s, the BoJ is worried about phantom inflation when it should be focusing on ending the deflation. Japanese policy-makers already nipped one recovery - in 1997 - in the bud by raising the value-added tax. Are they really dumb enough to do it again? The reasons the BoJ is purportedly so keen to raise rates, if only by a pinch, is o force companies to restructure and to create some breathing room in case there's a need to lower rates in the future.
Huh? Let's start with the first notion. The idea that keeping interest rates at zero is promoting lending to losing operations, if I understand it correctly, is preposterous.
"The stupidity of that idea is that it sounds as if lenders don't care if they get repaid their principal," says Bob Laurent, professor of economics and finance at the Illinois Institute of Technology's Stuart School of Business.
If higher interest rates are the means toward restructuring, why raise the overnight rate to 0.25%? Why not push it up to 5% and get some major restructuring?
The central bank's role is macroeconomic, not microeconomic, management. It's not supposed to direct money to certain institutions and businesses and away from others, which is something Japan's policy-makers have yet to grasp. The second reason for raising interest rates - to give the BoJ room to lower them - is even dumber.
If the BoJ thinks things may get worse, necessitating a rate cut, why raise rates now? In fact, the BoJ should be pumping more reserves into the banking system by buying all those JGBs that the Ministry of Finance is issuing to finance massive fiscal spending.
Finally, policy-makers like to fall back on the argument that an increase in the overnight call money rate to an expected 0.25% from 0.02% won't do any harm. Instead, why not do something that has a chance of doing some good?
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