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Land of the Rising Shun – Will a New Japanese PM Push out the Current Central Bank Regime?

robin anderson

That’s not tea brewing in Japan; it’s a bit of a political and economic storm. Oddly though, this isn’t a clash between Yoshihiko Noda, current prime minister of Japan, and Shinzo Abe (Noda’s presumptive successor if current polls are to be believed). Rather, there’s a growing enmity between Abe and the governor of the Bank of Japan, Masaaki Shirakawa. Abe, leader of the Liberal Democratic Party (LDP), is ahead in current opinion polls and could likely become the next prime minister. He’s also got some pretty bold ideas on monetary policy; bold enough that he’s been getting jabs from Shirakawa, whose term as Japan’s head central banker expires in April 2013. And these statements are causing market movement.

The Bank of Japan (BoJ) just concluded its November meeting and essentially kept monetary policy steady. It appears as if the BoJ is waiting to see what happens in the political arena before committing itself to further easing monetary policy.  If the LDP wins a majority in the upcoming election, the BoJ will likely have a markedly more dovish composition.  Abe is on the record for wanting the central bank to have an inflation target of 2% to 3% using unlimited easing measures.  If the LDP wins, we might see not only some tension with Shirakawa (remember, his term expires in April), but also some potential changes in the laws that govern the BoJ.

If Abe sounds familiar, it’s because he’s already been Japan’s prime minister. Back in 2006, he held the position for almost a full year. Well, now he’s back, he’s popular, and he’s been pushing for near-zero or below-zero interest rates to further stimulate the economy and prices. While markets have approved of Abe’s dovish calls (the Nikkei has been at two-month highs), Shirakawa probably feels that such unfettered easing could provoke Japan’s “bond vigilantes.” As they put it over at The Economists’ Free Exchange blog, “Pushing too aggressively for 3% inflation when Japan’s consumer price index has barely risen by more than 1% for decades could shock a country whose banking system is up to its neck in government bonds.” Further, and this is the real kicker, Abe has been on record saying that he would support forcing the BoJ to buy construction bonds directly from the government as a method of taming deflation. Outright debt monetization, which is what Abe is calling for, could cause yields on Japanese government bonds (JGB) to spike (those bond vigilantes at work) and, of course, piles more to the already-crushing Japanese public debt.

For what it’s worth, some analysts claim, though Shirakawa denies, that the big easing program the BoJ has engaged in this year is tantamount to debt monetization; the expected total of asset purchases announced in February – ¥38 trillion – was about equal to JGB issuance by the government this year.  However, it’s the degree of boldness in Abe’s statement and the call of direct central bank underwriting of government purchases that are controversial.

The market may likely continue to react to news surrounding the election – following the chances of LDP being elected or being able to form a majority coalition.  If LDP wins, that could be a positive for markets in the short run and a negative for the yen.  There is no doubt that Japan’s central bank must continue its battle with deflation and will likely continue to have the deal with political pressures for more easing, regardless of the December election’s outcome.  And Abe’s election could be the bold kick in the pants Japan needs to fight its long battle with deflation. That said, explicit debt monetization undermines Japan’s credibility in its dealings on fiscal issues and, most importantly, central banks must remain independent.

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