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Bank of Japan's governor under pressure from critics

"The BoJ's latest move shows only that either it's willing to be more flexible or that it's easily bullied by politicians."

Ronald Bevacqua, senior economist at Commerz Securities Japan Ltd

If anyone knows what Bank of Japan Governor Masaru Hayami is going through these days, it's Paul Volcker. In the late 1970s and early 1980s, the former Federal Reserve chairman was perhaps the most despised American.

Hayami today enjoys that dubious honor in Japan.

Volcker was hired to stabilize an economy plagued by double- digit inflation, and he did just that. US prices were growing at 14 percent when he took the top Fed job in 1979. That dwindled to less than 4 percent by the time he left in 1987.

While Volcker is a hero today, he was anything but 20 years ago. Hate mail piled in and protesters burned his body in effigy outside the US Federal Reserve's Washington headquarters. Security officers began checking incoming boxes for bombs. One detractor even brandished a machete in the Fed's boardroom.

Hayami's life, as far as we know, isn't being threatened these days. But just as Volcker was, he's being demonized for doing his job. Also, like Volcker, Hayami is getting panned for keeping too tight a hold on the money supply. Odd thing, since he's already taken BOJ policy into uncharted territory, driving rates to zero percent and going further to boost the money supply.

And just like the former Fed chief, Hayami has embraced a form of monetarism to achieve his goals.

In reality, Hayami is no more a monetarist than Volcker. For Volcker, targeting money supply was the economic equivalent of a Trojan Horse. Embracing the idea that one could control an economy by closely controlling the supply of money gave Volcker political cover to do what he needed to do -- drive short-term rates to 20 percent. Thanks to the arcane language of monetary science and price stability, Volcker was able to, as he put it, ``break the back of inflation.'' Hayami's so-called ``quantitative easing'' strategy is a Trojan Horse with different stripes. The idea is to target money growth, rather than interest rates. Hayami is doing this even though he doubts printing more yen will help an economy suffering from a lack of demand for money, not the supply of it. It's a political smokescreen designed to get critics off the BOJ's back.

Yet Hayami is having a more difficult time with politicians than even Volcker had. The irony here is that the BOJ's policies are moving in the direction Tokyo wants, although more slowly than politicians would prefer.

Whereas Volcker was hiking rates in the face of calls for lower ones, Hayami is loosening them at a time when the government wants him to do just that.

All of this raises messy questions about central bank independence. No one doubted the Volcker Fed's autonomy. In fact, President Ronald Reagan eventually dumped him in favor of Alan Greenspan, someone Reagan felt was more aligned with his views.

But the BOJ doesn't enjoy that standing with markets, and last week's move to boost liquidity only complicated things.

"The steps themselves, and the atmosphere and circumstances under which they were taken, may reduce the credibility of the BOJ," says Takehiro Sato, an economist at Morgan Stanley Dean Witter (Japan) Ltd.

Granted, the BOJ has never been as independent as the Fed or the world's other monetary superpower, the European Central Bank.

Still, the BOJ hasn't distanced itself from the government as much as global investors want. The skepticism reflects the central bank's role in stabilizing the economy in recent years. By lowering short-term rates to zero percent, the BOJ has enabled Tokyo in its failure to implement structural policy changes.

Cheap money has allowed banks to stay in business and to carry deadbeat companies. It's also provided support to the stock market. All told, the BOJ's easy-money policies have kept Japan's economy functioning all these years. As such, the central bank must bear some of the responsibility for Japan's 11-year slump.

Last week's surprise action drew similar complaints. It's not hard to understand why Hayami raised the target for the outstanding balance of deposits held at the central bank to Yn6 trillion from Yn5 trillion. For one thing, the move sapped some momentum from the BOJ's critics. For another, it turned the spotlight back on politicians who now have no one to blame but themselves for Japan's troubles.

Yet the risks inherent to the BOJ's action became clear in the days that followed. Far from being satisfied, government officials demanded even more from Hayami. With the economy set to deteriorate further, politicians argue, the BOJ shouldn't stop now. It's like the old adage: Give someone an inch and he or she will take a mile. The BOJ must now figure out how to quench politicians' thirst for more yen printing.

"The BOJ's latest move shows only that either it's willing to be more flexible or that it's easily bullied by politicians," says Ronald Bevacqua, senior economist at Commerz Securities Japan Ltd. "Either way, it opens the possibility of further easing." The upshot may be the loss of Hayami's "adult" status in the Japanese economy. While Tokyo has run away from reform for a decade, relying on public works spending to boost growth, the BOJ has been a voice of sobriety. Yes, it has provided help to the government -- too much, in fact -- but the BOJ also has worked to pressure politicians to fix the economy.

If the BOJ loses even more credibility with markets and its moral-high-ground position with Japan's government, its influence will wane. It's here where Hayami could take a page from the Volcker playbook. As Fed chairman, Volcker stood his ground against politicians, and the US is better off for his efforts.

Hayami has similar powers in Japan. Let's hope he uses them.
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