Japan’s Monetary Policy Misadventure

This paper argues that the Bank of Japan’s decision in April 2013 to formally adopt inflation targeting as the framework of its monetary policy and to embark on a programme of quantitative and qualitative monetary easing was misconceived. The aim of the policy to achieve consumer price inflation of two percent on a sustainable basis has not been achieved. It is ill conceived because Japan’s deflation during the past two decades has been quantitatively small with evidence that a substantial part of this deflation is a statistical artefact. Furthermore, much of the fall in growth rates can be explained by a combination of a shrinking labour force and falling working hours. A large part of Japan’s fiscal deficits is structural, reflecting ballooning social security expenditure for the elderly which policy makers are unlikely to be able to reform. Weakening fiscal discipline implies that monetary policy in Japan is a de facto open monetization of government debt. When a crisis comes, the Bank of Japan will have no option but to continue financing government deficits even if the inflation rate climbs beyond its official target in the future.