May 29, 2014 12:00 am JST

Government, central bank must work in tandem

TORU YOSHIDA, Nikkei economic news editor

TOKYO -- The Bank of Japan's Haruhiko Kuroda has earned a reputation at home and abroad as a deft hand.

     The Banker, a finance magazine, named him its 2014 Central Banker of the Year for "the bold and decisive way in which he implemented (an) aggressive monetary policy."

     Under Kuroda, the BOJ has set a goal of achieving inflation of about 2% in two years and has pursued it through quantitative easing, which weakened the yen and raised expectations of price rises. The core consumer price index was falling when Kuroda took office in March of last year; its latest reading was a 1.3% gain compared with a year before.

     The bank's monetary policy is clearly having its desired effects, Kuroda told The Nikkei in a recent interview. While the BOJ is more than halfway to its target, risks lie ahead.

     Domestic supply-demand forces, such as labor shortages, will replace higher import prices as the main driver of inflation from the second half of this year, according to the central bank. It sees prices continuing to rise gradually, even after the effect of the weak yen wears off. Inflation may reach 2% as early as mid-2015, the BOJ says.

     Many in the financial markets disagree. They figure that once the impact of the yen's depreciation is absorbed, downward pressure on prices will increase, pushing inflation below 1% and compelling the BOJ to ease further.

In a corner?

Aggressive monetary easing and the yen's reversal did wonders for the Nikkei Stock Average, too, but it has now lost last year's vim. Prime Minister Shinzo Abe is said to be keeping a close eye on share prices. If they start plunging, the central bank may find itself under pressure from the government to ease further.

     Kuroda told The Nikkei that the bank would provide additional easing "without hesitation" if needed, and that it has "various possibilities" at its disposal. But the BOJ has been buying huge volumes of Japanese government bonds since last year, leaving it few policy options. Moreover, its actions produce side effects, including increased volatility risk for long-term interest rates. What Japan needs from central bank policy now is not only bold strokes but more precise ones. Maintaining such a balance is no easy task.

     BOJ easing has done well as the first "arrow" of Abenomics, the prime minister's vision for ending deflation and invigorating the economy. The second, fiscal stimulus, has supported Japan's economic recovery. The problem is the third arrow -- efforts to boost growth.

     One of the greatest challenges facing Japan has been pushing through bold deregulation to create the new markets and productivity gains needed to achieve post-deflation growth. Worn-out production capacity, scarce labor and other problems that lay hidden during the deflation years have reared their heads, Kuroda warned, and require solutions. Unless the government and the BOJ can work in tandem to create an environment that encourages private investment, the BOJ's bold monetary easing may have been for naught.