Expect more of the same policies from the Bank of Japan (BOJ) for the indefinite future. The BOJ will continue to keep the short-term interest rate at or near zero and afford modest growth in the monetary base.
The interesting thing is that on Friday the BOJ gave a somewhat sanguine outlook about the country's growth prospects when it forecast that the economy will grow by 2.5 percent through the fiscal year 2003, which ends in March next year.
Still, BOJ Governor Toshihiko Fukui said that he views the economy through "cautious eyes." The problem, as he must see it, isn't growth; it's deflation, which is defined as a sustained fall in the consumer price or producer price level. Many economists view deflation as seriously as the collapse of the nation's banking sector.
The BOJ report forecasts consumer price deflation will endure past the March end of the fiscal year. The median forecast of BOJ's nine-member board calls for a drop of 0.3 percent in prices for the current fiscal year.
Fukui takes this very seriously. On Friday he said, "The Bank of Japan aims at putting Japan's economy back on a sustainable growth path by firmly maintaining the quantitative easing policy based on clear and concrete commitment with reference to the CPI." Now how could it be the case that an annualized decline of 0.3 percent in prices could achieve such importance in monetary policy? There's something unsettling about the price of goods falling on a consistent basis. People sense something must be wrong with the economy. This may be a legacy from the Great Depression, when falling prices became a symbol of the economic crisis.
Stock prices go up and down. When the price of rice or potatoes drops year after year, consumers have to wonder what's wrong with the economic system.
The cure offered by the authorities is often worse than the disease. While the phenomenon originates from monetary policy -- insufficient growth in the money supply -- governments often react by trying to control the price of goods and the level of production.
That's what was so tragically wrong about the policies of president Franklin D. Roosevelt's administration in the 1930s.
The New Deal policies tried to cure the depression by keeping prices from falling to protect producer profits. This in turn protected jobs.
Only a scoundrel would cut his price, so it was thought, and so it was enacted into law.
This idea is a fast trip to the belief that competition among suppliers is a harmful exercise. Follow this and you'll end up with no measurable deflation and no growth, either.
Japan today may have been a victim of the same knee-jerk reaction to deflation that prolonged the US depression in the 1930s. When prices fall, governments become protectionist.
The Japanese government's reaction to the last 13 years of economic malaise and accompanying deflation has been to block the competitive reconstruction of the economy.
You see this everywhere you look, in the forestalling of corporate bankruptcies and in banks continuing to lend to non-performing loan clients. The country has been on a mission to save companies from having to face competitive forces.
If prices need to fall, they need to fall. And if businesses are pressed by falling prices, then they need to be pressed.
Extending credit and other lifelines to companies that are technically insolvent does no one a favor.
For its part, the BOJ is right to continue to expand the money supply. That part is axiomatic, though it is far from certain that the BOJ has done enough money creation to curb falling prices.
The rest is experience. And this much is clear: A little bit of deflation can be the father of a great deal of very harmful policy response.
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