NIRA Policy Review

Edited by Motoshige Itoh 2013.5

No.60

Looking at Policies
Aimed at Ending Deﬂation
Policies seeking to end deflation, the most pressing issue for the Japanese economy, have been put into effect.
However, there is some skepticism with regard to the effectiveness of quantitative easing in ending deflation,and significant concerns exist regarding a possible exacerbation of the latent risk of further increase in thenation’s fiscal deficit. While indicating the importance of inflation targeting and aggressive monetary policy ineliminating deflationary expectations, the experts interviewed in this issue of the NIRA Policy Review pointout that it will also be essential to maintain fiscal discipline and implement effective growth strategies in orderto end deflation.

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A “Rocket Start” to Realizing
an Exit from Deﬂation
Motoshige Itoh

President, National Institute for Research Advancement (NIRA)□ Expert Opinions □Exiting from Deﬂation: Is the Prescription Strong Enough?
Indicate post-deﬂation destinations
for the economy

Increasing the brand power ofJapanese companies

Professor, School of Government, Kyoto University

Director and Chief Economist, The Totan Research Co., Ltd.

Kunio Okina

Towards more active monetary easing

Takeo Hoshi

Professor, Stanford University

A New vision: a population of 100 million
and GDP per capita of 70,000 US $Takashi Mitachi

Co-Chairman-Japan, The Boston Consulting Group K.K.;
Vice Chairman of Japan Association of Corporate Executives

Izuru Kato

Now is the perfect time to break awayfrom the three aspects of deﬂationary mindset

Hajime Takata

Managing Executive Officer and Chief Economist,
Mizuho Research Institute, Ltd.

NIRA Policy Review No.60

Motoshige Itoh President, National Institute for Research Advancement (NIRA)

Japan as a nation is entirely immersed in deflationary mindset.
The university students who I teach have experienced nothing but
a deflationary economy since birth. My generation experienced
the spiraling prices of the 1970s and the bubble economy, butthese are distant memories.
One hears opinions from every corner to the effect that even if
efforts are made to achieve an exit from deflation throughmonetary policy, the effect will appear only temporarily, andthere will be no improvement in the economy and no increase in
prices. It would seem that during Japan’s long period of deflation
the spirit of defeat has taken root and become endemic in
Japanese economic thinking.
A certain level of aggressiveness in monetary easing measures
will be essential to enabling us to break out of this situation. On
this point, there seems to be little disagreement among theexperts interviewed for this issue.
As Professor Takeo Hoshi points out in these pages, many
people believe that the Bank of Japan is the only central bank of amajor nation which did not sufficiently pursue monetary easing
following the global financial crisis. The current signs of correctionof the extremely high yen, increases in stock prices, and correctionof deflationary expectations resulting from the increased
expectations towards accommodative monetary policy ushered inby the Abe administration can be seen as a process of making up
for the four-and-a-half years lost since the Lehman shock.
And as Hajime Takata further indicates, the increases in stock
prices and real estate prices which will result fromaccommodative monetary policy also have an important meaning
in terms of doing away with deflationary mindset. Rather than
throwing our hands up over possible over-heating of the economy
or the development of a bubble when asset prices begin to
increase slightly, we should remain calm and simply observe theeffect that these increases have on eliminating the deflationary
mindset which has become endemic in the economy.

Structural change in the Japanese economy
While ending deflation has desirable aspects for Japan, it will

not be simple. One reason that the policies known as“Abenomics” have realized a strong start is that from the latter
half of last year the world economy switched to a risk-on1 posture.
Capital began flowing into emerging economies, and the firstsigns of recovery began to appear in the stock markets and realestate markets of major nations. The U.S. economy is also on arecovery footing at present. Now is precisely the time for the Abegovernment to launch its “three arrows” and initiate a “rocket
start” to achieving an exit from deflation.
The lack of movement in consumption and invest ment
despite the fact that the groundwork for ending deflation has beenlaid clearly indicates that ending deflation will not be a simple
matter. As Mr. Takata informs us, despite the fact that the private
sector has accumulated a massive amount of funds as a result of
the ongoing correction of balance sheets for the past 20 years,
there is no inclination to undertake investments involving risk.
Mr. Takata sees this as a deep-rooted lack of aggression.
Precisely because of this situation, it is important to send out astrong message and eliminate deflationary mindset.
As a number of the experts interviewed in this issue point out,
it will be important to ultimately achieve sustained growththrough innovation and similar strategies. It will be difficult tocontinue by influencing expectations alone. It is essential toproduce results and realize sustained growth.
Izuru Kato tells us that “unless the government continues togive the impression that it is steadily implementing medium- tolong-term policy, the strands of Abenomics will begin to unravel.”
Further, Takashi Mitachi states that “At present market
expectations are increasing, but the majority of companies havenot changed their behavior. Unless they can be convinced that
there is potential for long-term growth in the Japanese economy,
it will be difficult to make progress in ending deflation.”
Again, looking at the situation from the perspective of fiscal
problems, Professor Hoshi points out that “The government needs
to implement a growth strategy that places deregulation andinternationalization at its center and encourage innovation in theprivate sector,” eschewing reliance on support from government
expenditure as much as possible. From the perspective of fiscal
risk also, in order to end deflation while realizing sustained
growth it will be important to shift demand to the private sector,
and in order to do so it will be necessary to boost the potential
growth rate.
➡

Can we do away with deﬂationary mindset?

What ﬁscal policy tools are available to us?

The use of monetary policy alone has limitations

Leaving aside discussion of the relative merits of the policies,
there is a shared awareness among the experts interviewed in thisissue regarding the fiscal policy menu necessary to increasing thesurety of achieving the inflation target which has been set. Thismenu includes increasing the amount of government bondspurchased, purchasing government bonds with longer maturity
periods, purchasing higher-risk assets such as stocks and realestate-related
securities,
andpurchasing
foreigncurrency-denominated securities. Among these, arguments for thepurchase of foreign currency-denominated securities seem tohave become subdued recently. Both the government and the BOJ
are sensitive to Japan’s monetary easing being seen as an effort tomanipulate the exchange rate. Haruhiko Kuroda, the new
Governor of the BOJ, who has long experience of the world ofinternational finance, has stated clearly that the purchase offoreign currency-denominated securities is undesirable.
Expert opinion is divided concerning whether risk assets orgovernment bonds with longer maturities should be purchased.
There are reports that BOJ Governor Kuroda is considering theactive purchase of government bonds with longer maturity
periods. Anticipating this direction, market interest rates havereacted to its implications, and there is a conspicuous tendency
towards decline in the interest rates of long-term bonds2.
However, thinking from the perspective of a shrinking of theswollen balance sheet of the BOJ at some stage in the future,
Professor Kunio Okina points out that risk assets such as stocks
and real estate-related securities are more desirable thanlong-term government bonds. If the BOJ takes on an enormous
amount of longer-term government bonds, their sale in highvolumes on the market will not be a simple matter from theperspective of bond management policy. Mr. Kato agrees with
this, indicating that the selling of long-term government bonds as
an exit strategy for the BOJ will be difficult in practice. In thecase of risk assets, by contrast, assuming that the market is strong,sale of the assets would be relatively simple for the bank.
Professor Okina, however, contends that this “would result inexcessive exposure to risk for the BOJ, [and] it would be
essential for the government to accept the impairment of thebank’s balance sheets, and provide support as necessary.” Mr.
Kato also points out that if the BOJ becomes fiscally dependent
on the treasury in the event of problems appearing in its balance
sheet following the purchase of risk assets, its independence will
decline, and it will become unable to extricate itself fromobtaining financing via treasury funds.
However, it is also true, as Professor Hoshi points out, that one
aspect of aggressive monetary easing is the influencing of
expectations by implementing large enough monetary easing thatis hard to reverse.

Having indicated that aggressive monetary policy is essential
to ending deflation, it is clear that monetary policy alone is not
sufficient. It is necessary to realize an ongoing expansion ofdemand in order to institute an upward trend in prices. In addition,
the more accommodative the monetary policy, the more difficult
it becomes to consider monetary policy and fiscal policy
separately.
As Professor Okina stresses, it will be important to proceedwith realizing fiscal soundness, and to “indicate destinations thatcan be reached even without financing from the BOJ.” Professor
Hoshi also points to the risk represented by an increase in
outstanding government bonds. This sounds a warning: As we
pursue aggressive monetary easing, it is also essential toconsolidate fiscal expenditures as much as possible.
Mr. Mitachi and Mr. Kato stress the importance of growthstrategies. Aggressive monetary easing and deficit financing are
effective in realizing the present goal, exiting from deflation, inthe short term, but cannot maintain this state in the long term. We
must find a course by means of which the economy is able toachieve ongoing growth without excessive monetary or fiscal
stimulation. Unless we promote technological innovation andboost latent growth potential, we will be incapable of presenting
a vision of the future recovery of the Japanese economy.
It will no doubt take some time before the effects of growthstrategies actually appear in the economy. However, it is also
necessary to consider that the potential for future economic
growth influences expectations. Despite the fact that it would
take time for the effects to be felt in the real economy if thegovernment moved to early implementation of effective growthstrategies, such growth strategies could be expected to play anenormous role in doing away with deflationary mindset.

➡

A “Rocket Start”
to Realizing an Exit from Deflation*1: A market state in which investors take risks and actively seek returns (profits).
*2: This essay was written in March 2013. In April 2013, the BOJ decided, at its
first Monetary Policy Meeting under its new Governors, to increase thepurchase of government bonds with longer maturity periods.

Motoshige Itoh:
President, National Institute for Research Advancement (NIRA), 2006 – present.
Professor, Graduate School of Economics, The University of Tokyo.

NIRA Policy Review No.60

A New vision: a population of 100 million
and GDP per capita of 70,000 US $Takashi Mitachi

Expert Opinions

Exiting from Deﬂation:
Is the Prescription Strong Enough?

Co-Chairman-Japan, The Boston Consulting Group K.K.;
Vice Chairman of Japan Association of Corporate Executives

We are seeing a solid beginning to eﬀorts to exit from deﬂation in Japan, with the introduction of inﬂation
targeting by the Bank of Japan and the formulation of new growth strategies by the government.
But is the policy menu suﬃcient to the task? And if not, what policy orientation would be desirable in the future?
We sought opinions from academic economists, economists working in private enterprise, and experts at theforefront of the business world.

Interviewer: Motoshige Itoh, NIRA President
Period of interviews: February - March, 2013

Indicate post-deﬂation destinations forthe economy
Kunio Okina

Towards more active monetary easing

Professor, School of Government, Kyoto University

Professor, Stanford University

For some time now, the Bank of Japan has presented an imageof the ending of deflation. If the goal is merely to hasten theachievement of this goal, several methods are available. The
problem is how to return monetary policy to its original state
when we have moved beyond deflation and the extraordinary
monetary easing has been terminated, or when these goals are insight. It is essential that policy should be implemented prudently,
with this in mind. The extension of the maturity period forgovernment bonds will be a danger at this time. By contrast withgovernment bonds, the purchase of risk assets would presumably
be an easy method of returning the situation to normal, because
they could be sold when their prices increase. However, because
this would result in excessive exposure to risk for the BOJ, it
would be essential for the government to accept the impairmentof the bank’s balance sheets, and provide support as necessary.
In addition, while the precision of pinpointing the 2% inflation
rate target is increasing, after the achievement of the target figure,it will be necessary to allow fluctuation above and below 2%
within a specified range, in order not to hamper the flexibility
with which monetary policy is implemented, to ensure that policy
returns to normal without losing the confidence of the market.
The fact that it is becoming difficult to discuss monetary policy
in isolation from fiscal policy is a serious problem. While the
BOJ is engaged in its efforts, the government should indicate
destinations that can be reached even without financing from theBOJ, for example the reform of the social security system and theraising of the consumption tax. We must not reach a situation inwhich the inflation target has been achieved but our economic
and fiscal state remains poor. ■Deflation is a monetary phenomenon, and as such is a problem
which can be solved by monetary policy. Given the fact that the
adoption of an expansionary fiscal policy is difficult for Japanand the interest rate is already at zero, the only monetary hope is
to lower the future interest rate and increase inflation expectation.
However, the monetary easing by the BOJ under Governor
Shirakawa was insufficient. It did not stimulate inflation
expectation and also dampened the duration effect of the zerointerest rate policy.
As a method of clearly communicating the goals of monetary
policy to the market, inflation targeting is an excellent framework
for monetary policy. But with the short term interest already atzero, it will not be easy to achieve the inflation target quickly.
From this perspective, price level targeting, which would require
the central bank to aim a higher inflation rate if the inflation rate
falls short of the target, may be more effective than inflation
targeting. Implementing large enough monetary easing that is
hard to reverse would also be effective.
One potential problem of successful monetary easing is thatthe interest burden on government debt will increase as thenominal interest rate will increase with inflation. Japan must
avoid any further worsening of its public finance. The
government needs to implement a growth strategy that places
deregulation and internationalization at its center and encourages
innovation in the private sector. ■Takeo Hoshi

The chief characteristics of Abenomics are the fact that itprioritizes influencing the market psychologically, and it adopts
high-risk and high-return policies, i.e. it takes the risk ofgenerating side effects. At present market expectations are
increasing, but the majority of companies have not changed their
behavior. Unless they can be convinced that there is potential for
long-term growth in the Japanese economy, it will be difficult tomake progress in ending deflation.
One of the fundamental causes of the stagnation in domestic
investment by Japanese companies is their perception that a
reduction in the scale of the economy is unavoidable given the
decline in the nation’s birthrate. In order to change thispessimistic outlook and halt the decline in the birthrate itself, thegovernment should present a crystallized vision aiming towards a
population of 100 million people and a GDP of 70,000 U.S.
dollars per person. In addition to outlining a long-term policy tohalt population decline at a population of 100 million, Japan must
become a nation possessing a high degree of competitiveness inindustries such as agriculture, tourism, and B2B services, like
Switzerland, northern Europe and Hong Kong.
In order to realize growth strategies, it will also be important
for the government to offer narratives to provide the weft for the
warp of the three councils that it has organized, including theCouncil on Economic and Fiscal Policy. One narrative, forexample, might be a consistent flow from an increase in theworking population, to an increase in the female labor
participation rate, the stimulation of the child-minding andeducational services industries, and the reform of regulations toenable its realization. I believe that it will also be essential tocontinuously take on board demands for the reform of regulations
and to establish bodies possessing the legal basis to makedecisions, beyond the boundaries of the authorities withjurisdiction. ■Increasing the brand power of Japanesecompanies
Izuru Kato
Director and Chief Economist, The Totan Research Co., Ltd.

Japan must walk a fine line as it aims to exit from deflation inorder not to induce a precipitous decline in the price ofgovernment bonds. To this end, the BOJ has sought an approach
which, rather than directly increasing expectations towards
inflation, increases expectations of medium- to long-term growth,with the result that prices increase. However, the BOJ has failed
to adequately explain its position; it is not understood by the
public, and the BOJ has become a scapegoat when economic
problems are thrashed out.
Cause for concern is presented by the potential for it to become
difficult, in practice, to sell Japanese government bonds as an exit
strategy because the major purchasers of the bonds are domestic
financial institutions; for a decline in the independence of the
BOJ if it becomes fiscally dependent on the treasury when it
records a loss on its balance sheet; and for the BOJ to be unable

to untangle itself from treasury financing.
From the perspective of eliciting the greatest psychologicaleffect from its announcements, putting the “increase inflation to2%” ball into play is an effective move for the BOJ. However,unless the government continues to give the impression that it issteadily implementing medium- to long-term policy, the strandsof Abenomics will begin to unravel. In order to prevent this, itwill be essential for Japan to accept highly-qualified migrants andto work to maintain the vigor of Japanese society as a whole. In
addition to increasing their technological capacity, it will benecessary for Japanese companies to study the brand strategies ofGerman companies and to increase their brand power and secure
an adequate profit margin in order to create an environment inwhich wages can be readily increased.
■

Now is the perfect time
to break away from the three aspects ofdeﬂationary mindset
Hajime Takata
Managing Executive Officer and Chief Economist,
Mizuho Research Institute, Ltd.

In the process of adjustment of the balance sheet which has
continued for 20 years since the collapse of the bubble economy,
the Japanese economy has entirely lost contact with growthscenarios and expectations of future improvement, anddeleveraging, deflationary mindset, and a lack of aggression havetaken root as a three-part set.
Responding to deflation is not symmetrical with responding to
inflation. And fully mobilizing monetary policy and fiscal policy
is necessary for responding to deflation. In this respect, theannouncement of a 2% inflation target can be positively
evaluated as sending a strong message.
At present, the marshaling of policy in an attempt to do awaywith deflationary mindset is proceeding well. In the future, it willbe essential to develop growth strategies and foster expectations
towards improvement in order to put the economy on asustainable path. The ideal situation would be the realization of
growth through technological innovation, but realistically the
only option is to stimulate external demand by reducing thestrength of the yen. The strong yen has been a factor in
determining deflationary mindset since the collapse of the bubble
economy, and it will be necessary to induce a sense of security to
the effect that we will not immediately return to this situation. In
addition, initiatives in asset markets such as stocks and real estate
will be effective in continuously improving expectations for the
future. If the value of assets increases, demand for funds forinvestment will be generated, producing a recovery in facility
investments and a recovery in wages. Policies that support
increases in the value of assets are demanded. With theadjustment of the U.S. balance sheet that has continued since2007 now reaching its final phase, the upward pressure on theyen has ceased. Now is the perfect time for Abenomics toproduce results. ■This is a translation of a paper originally published in Japanese. NIRA bears
full responsibility for the translation presented here.

What’s NIRA?
The National Institute for Research Advancement (NIRA) is an independent, private-sector research
institute which defines urgent policy issues and formulates bold and timely policy proposals, seeking tocontribute to the revitalization and further development of Japanese society and the Japanese economy.
Utilizing a network of scholars, researchers, and specialists in a wide range of subjects, NIRA works forthe public benefit from a fair and neutral perspective, attempting to reinvigorate policy debate and contributeto the process of policy formation in Japan. The institute focuses on domestic social and economic policy,
international relations, and regional issues in Japan as its principal areas of research.
Established in 1974 as a government-authorized independent research institution, NIRA became anincorporated foundation in 2007, and since February 2011 has been recognized as a Public Interest
Incorporated Foundation.

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