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Debate: Debate on Fiscal/Monetary Policy #1 (August 19, 2002)

Don't Be Too Optimistic About Japan's Economy: More Quantitative Easing Needed

Nobuyuki NAKAHARA (Former Policy Board Member of the Bank of Japan)

Japan's economy is in the final stage of overcoming the aftereffect of the bubble in the 1980s. Banks currently are correcting their overlending position, and planning to reduce their loan balance by 20 trillion yen this year, in addition to their 30 trillion reduction last year. Because bank lending is being reduced sharply, firms are having trouble financing themselves, and the numbers of bankruptcies and unemployment will continue to increase. Therefore, the current short-term recovery might well be stopped. In addition, the stock market decline in the United States is likely to affect Japan's economy adversely. We should not be too optimistic about the future of the Japanese economy.

Then what should we do? We need to adopt a monetary policy of further quantitative easing. The bank of Japan's balance of deposit (commercial banks' deposit of money in the bank of Japan) hit 27.6 trillion yen in late March this year, but it has gone back to the level of 15 trillion yen since April. The balance target should be raised to 20 trillion yen. Also, the upper limit of market operations to purchase Japanese government bonds, which is currently 1 trillion yen, should be increased by 500 billion yen and a new operation to purchase foreign government bonds around 500 billion yen should be initiated.

Some say that bank lending does not seem to be increasing despite the zero interest rate and quantitative easing, and that even though banks have enough money they are not increasing lending but instead are buying government bonds. Thus, money is not circulating in the economy and monetary easing is not effective. However, we are in the process of correcting the overlending condition and therefore credit is contracting and lending tends to decrease. That is why we should adopt further quantitative easing to counteract such a tendency.

Actually, quantitative easing is intended to affect asset markets, especially to support the stock market and lower the value of the yen. We need to act now, before Japan's stock price falls substantially. Since banks are yet to liquidate much of their mutually held stocks, a sharp decline in the stock price would damage banks' balance sheets by yielding negative equity. We must take definite action such as an improvement in the stock buying organization. Also, a substantial amount of public funds may have to be injected into the banking system by making a necessary change in laws.

Nobuyuki Nakahara "Rakkan-ron ni igi o mohshi tateru," Economist (published by Mainichi Newspaper Co.), August 20, 2002

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