Almost exactly a decade ago, Ben Bernanke visited Tokyo as a member of the Federal Reserve Board – he was not yet the powerful Fed chairman – and gave some shocking advice to his Japanese counterparts. Surveying the country’s abysmal record of deflation, Bernanke recommended that the Bank of Japan set an explicit inflation target and embark on a massive program of buying government debt to help achieve that goal.
It took a perplexingly long time for the advice to be heeded. Last week, Japan’s new central bank governor, Haruhiko Kuroda, announced that he hoped to achieve 2 percent inflation within two years from the current deflation of -0.70 percent.
To accomplish this, the BOJ will double the size of the money supply to $2.8 trillion in two years by buying long-term government bonds, increasing its balance sheet by 1 percent of gross domestic product a month this year and 1.1 percent next year.
In short, Japan will attempt to do in two years what Bernanke and the Fed have done under their program of quantitative easing in five years. For the cautious Japanese, it was a breathtaking departure from recent practice, which had been constrained by fears that pushing up the inflation rate might bankrupt the BOJ because its large government bond holdings would lose value when interest rates went up.
While these measures are almost universally applauded, it’s an open question whether they will be enough to fix what ails Japan. No two countries are alike, so using a solution that worked well in the United States may prove less than a perfect fit for the Japanese. For example, increasing the money supply is no guarantee that banks will lend and people will start buying consumer goods, the ultimate end of a deflationary liquidity trap. In addition, the Japanese prescription depends in part on the revival of Japan’s export trade – all that monetary easing has led to a sharp decline in the value of the yen, which is supposed to boost the fortunes of companies like Sony and Toyota. But that may prove elusive as long as economies in Europe and the United States struggle with high unemployment.