The problem with targets…


The problem with targets is that eventually you have to either meet them or face the consequences of not delivering on the expectations you created when you initially announced them.

In the case of the BoJ and its inflation target of 2%, the problem is that anything less than 2% will (rightly or wrongly) be seen by the majority of market participants as a failure. What is worse is that the BoJ is aiming to achieve this target within 2 years. That is a fairly significant task for the Japanese central bank, and the pressure of a time constraint on top of the inflation target itself, raises the spectre of sub-optimal monetary policy decision making in the short term in order to reach this targets, with unintended negative consequences for the real economy in the medium to long term. In other words, what happens if in a year’s time inflation is only running at say an annualised rate of 0.8%. Will the BoJ feel pressured into opening the liquidity valve even further, thus risking losing control of the interest rates and thus jeopardizing the governments fiscal position even further, and also putting further pressure on the Yen with adverse effects on trade relations as a consequence?

We think that any improvement should be seen as just that, and anything that moves the Japanese economy back towards a more normal state of affairs with positive inflation and normalised consumer and corporate spending behavior should be welcomed, but the financial markets are bound to be focussed on the 2% number and the 2 year time horizon.

As pointed out here earlier, the real issue to be resolved is not deflation per se, but deep structural issue in the inefficient Japanese economy, alongside a rapidly growing and possibly ultimately unsustainable mountain of government debt. If an eventual improvement in the CPI through aggressive monetary stimulus brings with it the spectre of rising interest rates in a situation where government debt has ballooned even beyond the 245% of GDP currently projected for 2015, then this could have cataclysmic consequences for government finances and subsequently the entire economy. In other words, if the market eventually looses confidence in the policy announced by the BoJ and Prime Minister Abe’s government, and the BoJ can not maintain control of rates, then there will be no option but for the government to default.


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