BoJ floodgates expose Japan to danger

Sir, Your editorial ("Bank of Japan opens floodgates", April 6) is certainly correct in suggesting that the Bank of Japan risks having done too much. However, by overlooking the context of the highly compromised state of Japan's public financing in which the BoJ's bold policy experiment is being conducted, your editorial is downplaying the considerable long-run inflationary risks to the BoJ's strategy.

With a gross public debt to gross domestic product ratio in excess of 240 per cent, and with a primary budget deficit of 7 per cent of GDP, Japan's public finances are clearly on an unsustainable path.

Equally troubling is the rapid rate at which Japan's population is ageing and the correspondingly rapid rate at which its domestic savings rate is declining. This has to raise serious questions about how the Japanese government will finance itself over the longer haul without permanent resort to the BoJ's printing press.

Over the past few months, the anticipation of a change in BoJ policy has already led to about a 20 per cent depreciation of the yen against both the US dollar and the euro. A further depreciation of the yen, coupled with a rise in inflation towards the BoJ's 2 per cent target, will make it extremely difficult for the bank to exit its quantitative easing strategy.

In an environment of a depreciating currency and rising inflation, both domestic and foreign investors are almost certain to find Japan's currently very low long-term yields on government bonds highly unattractive.

Absent a medium-term strategy to place the country's public finances on a very much sounder footing, there is the all-too-real risk that the BoJ is leading the country down the well-trodden path of very much higher inflation.

There is also the risk that the BoJ might learn anew that one has to be very careful about that for which one wishes.

 

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Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
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    Email: dlachman@aei.org
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