The Bank of Japan has stepped into uncharted territory, unveiling a radical monetary policy to end two years of falling prices and support the rapidly weakening economy. The bank said it would scrap its traditional interest target and try to boost the volume of current account deposits, or reserves, lodged at the central bank.
"Japan's economy has failed to return to a sustainable growth path, and is now faced again with a threat of deterioration," the bank said in explaining its unorthodox move. "The Bank of Japan has decided to implement these measures with firm determination with a view to preventing prices from declining continuously as well as preparing a basis for sustainable economic growth," the bank said.
By flooding the banking system with extra funds through purchases of government bonds, the bank is resuming the 18month experiment with free money it abandoned last August. It expects the key overnight money-market rate to fall virtually to zero from 0.15 per cent now.
What is different from the last period of free money is that the bank promised to keep rates at zero until nationwide core consumer prices had stabilised at zero or above. Japan suffered unprecedented back-to-back annual declines in consumer prices in 1999 and 2000. The rate of fall has even accelerated this year, causing the bank's governor, Mr Masaru Hayami, to acknowledge the growing risk of a vicious deflationary cycle.
Mr Hayami had stoutly opposed a return to zero interest rates or radical steps to pump up the money supply, fearing it would underwrite reckless spending by Japan's politicians. But with the economy lurching lower and share prices dropping to 16-year lows, politicians at home and Japan's allies abroad intensified pressure on the bank to halt the tailspin.
Even as he announced the sea-change in policy, Mr Hayami stood by the decision to raise interest rates last August. "I don't think our assessment of economic conditions was too optimistic. And I don't think the decision to end zero rates was wrong," he said.
In practice, the bank will aim to increase the current deposits that banks and financial institutions hold at the central bank to around five trillion yen from four trillion now.
But some economists argue that creating more bank reserves is little use because it is the demand for loans, not the supply, that is lacking.
"The decision to raise bank reserves parked at the Bank of Japan will have no near-term impact on macroeconomic policy, say over a year or so, because this isn't a policy that can encourage the already withered demand for funds," said Mr Seiji Shiraishi, an economist with Daiwa Institute of Research.
But he said it helped to ease financial jitters over Japan's ailing banks, which are under pressure from the government to write off a huge volume of loans that went sour when a bubble in shares, property and other assets burst a decade ago.
