KUroda Haruhiko entered the Bank of Japan (boj) with a bang. When he became governor in 2013, the former Treasury Department official fired a “bazooka” with easy money to end decades of stagnation. the boj committed to buying large amounts of assets and introduced negative interest rates to meet a 2% inflation target. Along with the late Abe Shinzo, then Prime Minister, Mr. Kuroda ushered in a new era of economic policy.
Mr. Kuroda’s term of office is ending explosive, to. Consumer price inflation was above that boj‘s goal for nine months; it reached 4% in December, the highest level in 41 years. Officials have remained on the offensive — but the bank’s policy of “yield curve control,” a cap on 10-year Treasury yields, is facing its fiercest backlash since its inception in 2016. Kuroda’s successor, to be announced in early February, will have to decide the future of politics and maybe even oversee rate hikes. This requires skillful communication, impeccable timing, and good luck. Missteps could cause Japan’s economy to grind to a halt and return to deflation. They could also shake global markets.
The first question for the new governor will be when to catch up with the bazooka. the boj‘s surprising decision In December, widening the trading range to include 10-year bond yields was seen as the start of the process to allow more trading and improve the functioning of the market. Predictably, speculators tested the target and forced it boj to buy a lot of bonds. The bank’s holdings rose by a record $22 trillion in the month ended Jan. 20. yen (USD 169 billion) to a total of 561 trillion Yen. At its January meeting, the bank stood firm, but the battle is far from over. In a Jan. 26 report, the IMF called for more flexibility around the trading range.
Mr. Kuroda is said to have returned from the World Economic Forum in Davos more convinced than ever of the bank’s cautious stance. the boj notes that higher import costs, particularly for energy and food, have fueled inflation in Japan. These pressures may ease soon: energy subsidies will reduce costs; Signs that global energy prices may have peaked and US inflation appears to have eased give cause for caution. Most importantly, wage growth has not kept pace with price growth. Real wages have fallen for eight straight months, down 3.8% yoy in November, the sharpest fall in almost a decade. The bank expects inflation to ease to 1.6% for the fiscal year beginning April 2023, and to just 1.8% the following year.
Even a hawkish successor can wait until after this year shunto (Annual salary negotiations) before the change of course. Japanese companies have long hesitated to raise wages, citing weak growth. But with continued inflation, business leaders have started to change their minds. Keidanren, Japan’s business association, urged members to pay special attention to rising prices. Some multinationals and larger regional companies are promising hefty salary increases. Fast Retailing, the parent company of Uniqlo, a clothing giant, announced increases of up to 40%; Higo Bank, a regional lender in Kyushu, southern Japan, is planning a 3% increase in base salaries, the first such increase in 28 years. The question is whether the small and medium-sized enterprises, which employ 70% of Japanese workers, will follow suit. Definitely, boj Officials believe the cost of overshooting inflation is less than tightening too soon and missing a historic opportunity to change Japan’s attitude towards inflation.
The problem is that the cost of maintaining the current approach will only increase. the boj now owns 100% of some bond issues, causing bottlenecks for traders. Contrary to expectations, the bank bought more bonds than before the introduction of yield curve control. Buying them at their current high prices means that the boj is likely to incur large losses on its portfolio, especially if it has to sell bonds or raise short-term interest rates. Officials want to phase out yield curve control. That could mean widening the band again, raising the 10-year target, or going into shorter-dated bonds. In practice this becomes difficult. As experience with exchange rate pegs shows, political arrangements can change quickly.
the boj also risks falling behind the inflation curve and having to tighten quickly. Any normalization, let alone a quick one, will raise questions about Japan’s fiscal health. Some economists see Britain’s meltdown under Liz Truss as a cautionary tale emphasizing the importance of maintaining faith in government credibility. They worry about unknown unknowns in the financial system. Despite this, the Japanese government has announced plans to double spending on the military and child care without presenting a credible plan to fund those increases.
Who inherits the mess at the boj? Three current or former deputy governors head most lists. Amamiya Masayoshi, Mr. Kuroda’s right-hand man, has overseen the bank’s monetary policy for years. As a classical pianist, Mr. Amamiya would bring an intimate knowledge of the music boj‘s grades. Nakaso Hiroshi, who served as deputy for the first half of Mr. Kuroda’s tenure, is a financial markets expert. He helped launch Mr. Kuroda’s bazooka, but assumed that monetary policy was not a panacea and that more structural reforms were needed to boost Japan’s potential growth rate. Yamaguchi Hirohide, who held the post under Mr Kuroda’s predecessor, was a harsh critic of ultra-loose politics. All three are considered more restrictive than Mr. Kuroda, but while Mr. Amamiya and Mr. Nakaso would represent a difference of degree, Mr. Yamaguchi would be a species difference, signaling a desire for a cleaner break with the current regime.
The choice falls on Kishida Fumio, Japan’s prime minister. His approval ratings have fallen in recent months, leaving him in a weaker position within the ruling Liberal Democratic Party. The nomination of someone hostile to “Abenomics,” like Mr. Yamaguchi, would infuriate the powerful faction that Abe led. However, whoever is selected faces a minefield. No candidate has led a central bank, let alone through a situation like this boj. Putting on too much, too soon, or waiting too long to act would be a fatal misstep. Perhaps that’s why all three were reluctant to take on the post. As one government economics adviser whispers, “A job I don’t want is next boj Governor.” ■
