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REFILE-INSIGHT-Valentine's Day mission gives BOJ new personality
April 5, 2012 / 6:43 AM / in 6 years

REFILE-INSIGHT-Valentine's Day mission gives BOJ new personality

By Leika Kihara	
    TOKYO, April 5 (Reuters) - It was a secret Valentine's Day
mission involving only half a dozen Bank of Japan bureaucrats
who worked through the weekend preparing for the central bank's
Feb. 13-14 meeting.	
    The governor had just been publicly heckled by politicians
over seemingly endless deflation and a yen near record highs.
Bold steps were needed to restore the BOJ's standing, and
    "Until February, the BOJ's message was that mild deflation
was inevitable, and that it didn't need to act as long as the
economy was doing fine," said a source familiar with the central
bank's thinking. "That perception had to change."	
    The inner core working that weekend at the BOJ knew surprise
would be the key to success, and so abstained from the usual
practice of leaking plans to the media to massage expectations.	
    It worked a treat. Unsuspecting markets were stunned by the
BOJ's two-punch combination of adopting a 1 percent inflation
target and a hefty increase in its bond buying.	
    The yen was knocked down just as effectively as if the BOJ
had bought hundreds of billions of dollars in currency
intervention, and over the next month fell to an 11-month low.	
    Perhaps more importantly, the Valentine's Day surprise
marked a fundamental change in the way the central bank sees its
mission, how it will carry it out and sell it to the public.	
    The central bankers had been aware for some time of two
problems. First, with interest rates already near zero and the
economy mired in deflation, their conventional tools were not
working. Second, the BOJ had an image problem, perceived as an
institution always doing too little too late.	
    So the BOJ very deliberately sent investors and politicians
the signal they have been waiting for -- that it was ready to
deploy unconventional weaponry to lead Japan out of deflation.	
    "When you set a goal, you have to show that you're serious
about achieving it. You have to meet words with action," said a
senior official at the central bank.	
    The remaking of the central bank is only beginning. Over the
next year there will be new board members and possibly a new
governor - a chance to shape thinking on how to reinvigorate the
world's third-largest economy.	
    The challenge for all will be how to reconcile calls for
vigorous action to take Japan to its inflation goal - a level it
has not seen for nearly two decades save for a few blips - and
concerns it could be seen as bankrolling vast government debt.	
    The plan to shake up monetary policy started to take shape
in December, sources close the central bank said.	
    There was push to act in January when the yen was near
record highs and the risk of a disorderly Greek default loomed
large, and most in the nine-member policy board were leaning
toward action.	
    But it would take another month to convince Governor Masaaki
Shirakawa, who remains skeptical of what can be achieved by
pumping cheap money into an economy beset by structural problems
like an ageing population and shrinking workforce.	
    Those who have worked with him say he is particularly
uncomfortable doing something just for psychological effect, and
in his view that includes feeding more cash to banks that have
trouble absorbing the funds already available to them.	
    Central banks normally worry about containing inflation, but
Japan has been faced with persistent falls in prices. Deflation
weakens the economy because it encourages consumers and
businesses to hold off on spending because prices will fall, and
companies struggle to pass on higher costs of fuel and commodity
    Insiders say hostile grilling of Shirakawa in parliamentary
hearings the week before the February meeting may have persuaded
the soft-spoken career central banker to move.	
    Lawmakers demanded the BOJ set a clear inflation goal the
way the Federal Reserve had, repeatedly heckling the 62-year old
banker. At one point the jeers got so loud that they drowned
Shirakawa's voice, and it was all broadcast live on television.	
    "People who watched that scene would have thought the BOJ
wasn't doing anything to cure Japan's ills. That image had to be
changed," said a source with knowledge of the BOJ's thinking.	
    Tired of being a whipping boy for politicians who have long
shied away from fiscal reform, central bankers decided to wrest
back the initiative and also show some support to Prime Minister
Yoshihiko Noda, whom they view as best placed to put Japan's
tattered finances back in order.	
    With public debt at twice the size of the $5 trillion
economy, Noda's plan to double the sales tax to 10 percent is
under attack from those who say the economy is still too weak.	
    With even members of his own party opposed to the plan, Noda
needs all the help he can get and sources say the central bank
is ready to provide that to some extent.	
    The sources say that in contrast to past spells of tense
relations between government and central bank chiefs, Noda and
Shirakawa get along well and meet about once every three months
casually, sometimes over breakfast or lunch.	
    "There is now trust and a good working relationship between
the two sides," said a source with knowledge of the meetings.	
    But while relations between the finance ministry and central
bank have been less fraught since February, bureaucrats at the
ministry are still seeking further stimulus from the BOJ to keep
the economy strong enough to weather any future sales tax hike,
say officials with direct knowledge of the negotiations.	
    With Shirakawa at the helm, there will be tension between
those in the BOJ keen to sustain the psychological effect of the
central bank's new image of a bold deflation fighter, and his
supporters who are wary of using heavy monetary artillery too
    "He doesn't like 'big bang' steps. It's not his style," said
a former BOJ board member who worked with Shirakawa.	
    Indeed, the central bank has found itself playing down the
impact of its February move to temper expectations of further
bombshell steps. 	
    The board meets again next week, although markets expect
that any follow-up action to the February meeting will be
delayed until a late April meeting that includes a review of
macroeconomic forecasts.	
    Many who have worked with Shirakawa say the hard-working
perfectionist is cautious by nature and has a stubborn streak,
although the February moves show he is not an obstructionist.	
    His term as governor ends in April 2013. Theoretically
Shirakawa could be reappointed, but the government is likely to
look for someone willing to step outside the boundaries of
traditional central banking.	
    Toshiro Muto, a former finance ministry bureaucrat and
deputy BOJ governor who is considered a leading candidate to
succeed Shirakawa, says the central bank is already pursuing
quantitative easing, where the stimulus is measured by liquidity
released into the financial system rather than the level of
official rates, even if it is not explicitly using the term.	
    One step Shirakawa has been reluctant to make and which Muto
said could be necessary was to buy more longer-dated government
bonds to prolong the stimulative effect.	
    "Whatever it does might have to be small steps. But the
BOJ's next challenge is to come up with ways to further pursue
its quantitative easing policy," Muto told Reuters in an
interview on March 30. 	
    Shaping Shirakawa's caution is his experience in 2001-2006
as one of the elite BOJ bureaucrats who masterminded the central
bank's previous spell of quantitative easing, where it targeted
cash balances of commercial banks.	
    Shirakawa believes the cash was not funneled to productive
sectors and did not prevent Japan from slipping into a decade of
economic stagnation and grinding deflation.	
    Having joined the BOJ in 1972, he has spent most of his
career facing the traditional problem of containing inflation as
Japan's economy boomed and asset price bubbles grew, whereas
views of his younger cohorts have been shaped by economic
stagnation and deflation.	
    So while many BOJ bureaucrats agree that merely flooding the
economy with funds may not provide the spur to end deflation,
they are also not as concerned about the risk of asset price
bubbles re-emerging or inflation getting out of control.	
    And they worry that years of brow-beating by politicians
have eroded confidence in their institution and baby steps are
not enough to restore it.	
    "Markets got the impression the BOJ changed in February and
that's reasonable. It changed in the sense it is starting to
violate a rule it made for itself," said Teizo Taya, a former
board member who left the BOJ in 2004 and is now a professor of
economics at Tokyo's Rikkyo University.	
    A test for the new mindset will be what the BOJ does on
quantitative easing over coming months.	
    Under its asset buying scheme the BOJ only buys government
bonds of up to two years until maturity. But with two-year
yields already at 0.1 percent, any further increase in the
scheme would have to target five-year bonds to be effective.	
    That would blur the distinction between the asset-buying
scheme, intended to be a temporary stimulus, and another
operation where it buys 21.6 trillion yen ($263 billion) in
long-term bonds per year.	
    Buying more bonds would bring it closer to violating a
self-imposed rule that its government bond holdings should not
exceed the value of banknotes in circulation.	
    Muto says the central bank should not worry about its rules
too much if circumstances call for action.	
    "If the BOJ, out of necessity to prevent a plunge in bond
prices, needs to buy bonds beyond what's accepted under the
banknote rule for a certain period, it should do so," he said.	
    "The February action turned out as a surprise. The BOJ did
more than what was expected. On the other hand, there is room to
do more. The real test has only just begun."

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