Thursday, September 16, 2010

What should be Japan's monetary anchor?

I’ve been doing some cogitating about Japan’s monetary dilemma.

As readers will know, I have been arguing that the MoF/BoJ have the power to determine the external value of the yen if they make a particular dollar price their target and do whatever it takes to reach their target (see: Hong Kong).

However, such a policy must be announced and be credible (see: Hong Kong). The problem is that were Japan to follow my advice and target a particular Y/$ rate, Japan would be at risk of being accused by Treasury of “manipulating” their currency, giving rise to mandatory tariffs under some law. This has been a long-standing annual dance between Treasury and China, which has a dollar peg.

So, if Japan wants to avoid such a bilateral problem, they need a different monetary target.

Here they should take Bernanke’s advice and target nominal GDP growth. By this I do not mean a typical Japanese target which is "unfortunately” never actually met (see deflation). Deep apology, more of same.

I mean a hard and immovable target which requires a massive expansion of the BoJ’s balance sheet, primarily consisting of classic open market purchases of JGBs, a/k/a, monetizing the fiscal deficit (see: Third World).

By targeting nominal GDP instead of the US$ exchange rate, the BoJ would kill three birds with one big rock: (1) break deflationary expectations; (2) place the nominal economy on an irreversible growth track (good for stock market!); and (3) as an “unintended” by-product, depreciate yen.

Now, if Helicopter Ben resumes QE on a large scale, that might derail #3, but not #1 and #2, which are really critical.

The problem with this prescription is that the DPJ is not smart enough to pick the right prescription, while the BoJ (which is smart) is wedded to Trichet-style orthodoxy: “Why should we risk our credibility to rescue a corrupt regime that has almost bankrupted the country?”

In the end, if Japan has any hope, the government will revoke central bank independence (which is very recent) and implement inflationary monetary policy (a la FDR).

You should not hold your breath waiting for this to happen. Japan has always been a country incapable of making A versus B decisions. Under consensus government, everyone has a veto.

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