March 20, 2001

Japan's Bank Acts to Spur Spending to Revive Economy

By STEPHANIE STROM

TOKYO, March 19 — Japan's central bank changed course sharply today in the struggle to revive the stagnant Japanese economy.

The bank said it would try to stimulate consumer and business spending by pumping money into the banking system, by effectively cutting short-term interest rates essentially to zero and by promising to keep borrowing costs negligible until demand picks up and prices stop falling.

The announcement was a stunning about-face for the central bank, which for years had stubbornly resisted calls to give up its focus on keeping the money supply stable and flood the country with yen instead. Only the rate cut had been widely forecast, and that was expected to come only grudgingly.

"The bank has come to the conclusion that the economic conditions warrant drastic monetary easing, such as is unlikely to be taken under ordinary circumstances," the bank said in a statement.

By trying to put more money into the hands of consumers and companies, the bank hopes to spur spending on goods and services, which would tend to push up prices. That, the bank hopes, would encourage consumers who had been putting off purchases to buy before prices went up much more. 

In Washington, where President Bush was meeting with Japan's prime minister, Yoshiro Mori, officials at the Treasury and the White House were relieved by the Bank of Japan's decision. But the two leaders ended their meeting with only a vague commitment by Japan to confront its huge problems with bad loans and corporate debt.

As economic growth slows around the world, the precarious state of the Japanese economy, the second largest after the United States, has taken on greater urgency. The country's banking system is riddled with bad debts, previous stimulus packages built around public spending have had little lasting effect except to run up the budget deficit, and a short- lived revival last year, driven almost exclusively by exports, appears to have fizzled out.

Consumers and business people alike have so little confidence in the economic future that they have reined in their spending, and the slack demand for goods and services has depressed prices and asset values throughout the economy.

The move by the bank today completed the reversal of a tighter-money policy put in place last September after the economy had begun to show some forward momentum. The bank's governor, Masaru Hayami, has since been berated for squelching a nascent recovery, not least by Western economists and finance ministers and an increasingly influential group within the nation's Finance Ministry who have been agitating against the Bank of Japan's tightfisted policies for several years.

Senior politicians have also made a habit of beating up on Mr. Hayami and the bank. "The Bank of Japan has been a very convenient scapegoat for politicians, who are facing a tough election this summer, a downward trend in the economy and increasing demands for structural reforms," said James Malcolm, an economist at J. P. Morgan in Tokyo. "Today's move by the bank is therefore almost symbolic, in that it's saying, `O.K., we capitulated, now the ball is in your court.' "

By casting aside its longstanding objections and agreeing to give the political leadership's prescriptions for recovery a try, the bank has shifted the responsibility for the economy off its shoulders and onto the politicians' at a crucial moment. 

The Bank of Japan said its new policy was prompted by concerns about the ineffectiveness of Japanese fiscal and monetary policy over the last decade, about the slowing global economy, and about the pervasive deflation that is eroding prices, wages and asset values here. 

In practical terms, the central bank's board voted to increase the money supply by greatly expanding Japanese banks' capacity to lend. It will raise the amount of reserves the banks are required to keep in its custody by about 25 percent, to 5 trillion yen ($41 billion), and at the same time lend the banks the money they need to do so. With the greater reserves, the banks can lend much more without overstretching their capital. The move will have the effect of returning short-term interest rates to zero from 0.15 percent now. 

Moreover, the board said it would continue the policy until the consumer price index stops falling and remains flat or rises for a period of time. That commitment means the bank has implicitly adopted a tepid form of "inflation targeting," a policy of explicitly aiming to a step long urged on Japan by economists and long resisted by the Bank of Japan. 

The bank even suggested it would consider buying Japanese government bonds outright, a step it has resisted despite the blandishments of the political old guard. The move would guarantee the government will be able to finance its activities. But the bank said it would do so only when it deemed such purchases "necessary" — and it did not define necessary. 

"This is quantitative easing, although an extremely modest version of it," said Ronald Bevacqua, chief economist at Commerz Securities in Tokyo. "But in the board's defense, this is an incredible change of direction for the Bank of Japan, which has denied the necessity for this type of easing throughout the entire post- bubble era. In the context of what is possible in Japan, this is not a bad first step."

While the policy board did not say what its next moves would be, it did open the door for further steps in the same direction. Two members of the board will step down this year, one of whom, Eiko Shinotsuka, was an ardent proponent of raising interest rates. The government will probably fill their places with candidates who are more dovish on monetary policy. 

"We believe today's measures will be the final easing measures in the current cycle," said Mamoru Yamazaki, chief economist at Barclay's Capital in Tokyo, referring to the bank's moves over the last two months to lower interest rates. "The next step would be outright inflation- targeting, but it would be a long time before such an action is taken."

Economists debate whether increasing the money supply will actually have its intended effect of stimulating activity. The bank cannot force companies and consumers to borrow, and most seem disinclined to do so, even at rock-bottom rates. The Japanese financial system is already awash with money, and bankers say that only the least creditworthy borrowers are asking for loans.

"Easing like this makes a lot of difference if there's a credit crunch," Mr. Malcolm said. "But currently we aren't in that situation in Japan — although the risks of it may be increasing with a rise in bankruptcies."

In the United States, the Federal Reserve has several times acted to rapidly inject money into the banking system at times of impending crisis, most notably when a cash squeeze at an important institution like Citibank or Long-Term Capital Management threatened to disrupt financial markets. But deflationary conditions akin to those in Japan have not been seen in the United States since the Great Depression.

The bank's actions today may tend to push the yen lower against the dollar, as investors switch out of yen into currencies like the dollar where they can earn greater interest rates. A weaker yen would give a boost to Japan's mammoth exporters, which almost alone produced the brief surge in overall economic activity last year, and many analysts foresaw a decline in the yen's value even before the Bank of Japan acted. That effect will be undercut to some extent if, as expected, the Federal Reserve reduces United States interest rates on Tuesday. 

The yen was little changed in Tokyo trading after the bank's announcement, and fell slightly in value in New York to 123.03 to the dollar, near a two-year low. 

Still, the bank's eyes are clearly on domestic demand, not exchange rates. In its statement, it conceded the deflation Japan is seeing stems from too little demand, not only from structural factors like globalization or increased competition.

The government and the ruling Liberal Democratic Party have recently come up with plans to encourage Japanese banks to tackle their bad debt problems once and for all, and to unwind the longstanding system of mutual stock ownership between the banks and their biggest customers. Beyond prompting fears in world stock markets that the banks would start selling stocks heavily — there is no sign that they have actually done so — these plans are running into substantial political and practical obstacles, not least the requirement that banks set aside reserves to cover writedowns of loan and stock portfolios.

With the ruling party facing an uphill battle in elections for the upper house of Parliament in July, no painful measures are likely to be adopted before the fall.

In fact, senior politicians have amplified their calls for a supplemental budget of new public spending, even though the regular 82 trillion yen budget for the fiscal year that begins April 1 has not yet been enacted. Deficit spending from past supplemental budgets, long favored by policy makers and often urged on Japan by foreign governments, have left the country with a crushing national debt of about 130 percent of its gross domestic product.

"We're now at the limits of both fiscal and monetary policy, and that's where things get interesting," Mr. Bevacqua said. "The money's run out in terms of fiscal spending; they can't lower interest rates any further; and now, Japan's rich uncle, otherwise known as the U.S. consumer, has no money left in his pockets either."