Japan: Next Phase for the BOJ

Published on January 30, 2018

General consensus is that Bank of Japan Governor Haruhiko Kuroda’s term will be renewed by Prime Minister Shinzo Abe when it expires in April of this year. But that is far from a given.

*** Our understanding is that Hiroshi Nakaso, Deputy Governor of the Bank of Japan, is under consideration to succeed Haruhiko Kuroda at the helm of the BOJ if he is to be replaced in April. One alternative scenario we have heard would be to renew Kuroda’s term as a gesture of respect and appreciation for his service and accomplishments, with the expectation that he would then voluntarily step down and pave the way for Nakaso. ***

*** Nakaso is a seasoned veteran on the international stage, well-known to his counterparts at the other major global central banks. Most importantly, as a career central banker, he would represent continuity, but would also be well placed to manage the internal debate and increasing discord within the BOJ over the appropriateness of the institution’s current monetary policy and targets at this stage of the economic cycle – starting with the Kuroda regime’s fixation on hitting an elusive 2% inflation target at all costs when all the other economic indicators in Japan are so strong. ***

*** Transitioning to a Nakaso-led BOJ would also facilitate a revision of the fiscal pact between the government of Prime Minister Shinzo Abe and the central bank, paving the way for an expansion of the budget, and, if needed, another postponement of the second hike in Japan’s consumption tax rate, from 8% to 10%, that is currently slated for October of 2019. ***

Shifting to a New Regime

The Bank of Japan, under the leadership of Governor Haruhiko Kuroda, has earned plaudits – and the gratitude of Prime Minster Abe – for having finally beaten the specter of deflation in Japan through a combination of aggressive monetary policy and bold, innovative measures including, most recently, the micro-management of bond yields in a remarkably tight, -0.1% to 0.0%, range out to ten years.

But while full credit is due Kuroda for shaking the BOJ out of years of timid policies and half measures, the 2% inflation target he set for the central bank at the start of his term has proven elusive, if anything, despite his continued assertions to the contrary, including as recently as at last week’s World Economic Forum in Davos. Some might even call it embarrassing.

This continued failure to hit 2% has in turn revived questions over the appropriateness of that specific target to the aging and mature economy that is Japan. On a more practical and immediate level, it has raised questions over the need to continue to press quite so aggressively on the monetary accelerator, with all its potential distortionary effects on financial stability, when every economic indicator – except the inflation rate – is flashing bright green.

Kuroda acknowledged as much last year in opening the discussion of the potential negative impact of prolonged yield suppression on the transmission mechanism of monetary policy through financial institutions, the so-called “reversal rate” effect. The BOJ was quick then to disavow that this discussion meant anything whatsoever for immediate policy.

For all of Kuroda’s success, Abe appears to be open to a change in the leadership at the BOJ. And our understanding is that Hiroshi Nakaso, Deputy Governor of the Bank of Japan, is the leading contender to succeed Kuroda when his term expires in April of this year, if he is to be replaced.

Nakaso is a seasoned veteran on the international stage, well-known to his counterparts at the other major global central banks. Most importantly, as a career central banker, he represents continuity, but would also be well placed to manage the internal debate and increasing discord within the BOJ over the appropriateness of the institution’s current monetary policy and targets at this stage of the economic cycle.

Etsuro Honda, a well know “reflationist” and confidante of Prime Minster Shinzo Abe, who is currently serving as Japan’s Ambassador to Switzerland, has also been floated as a possible successor to Kuroda.

But the chatter among the politicians of Nagatacho and in Kasumigaseki is that for one, the influential economist and advisor to Abe, Koichi Hamada, does not appear to endorse the appointment of Honda. Honda, it is widely believed, would simply boost asset purchases even more aggressively to hit the inflation target, without a deeper pause to assess if hitting that 2% target at any price is, indeed, appropriate policy now. That ultra-reflationary leadership may perhaps have been best suited for another time.

Nakaso, while perhaps less flashy, is a steady hand and well-known entity with extensive experience in the international division of the BOJ, with a career man’s understanding of the institution. And it has not gone unnoticed that when asked for the key qualities he would look for in a BOJ governor, Kuroda himself cited an international perspective, with strong human relations capabilities.

Nakaso is a candidate that would be supported not just by the Abe cabinet, but extensively within the BOJ as well.

Expanding the Budget

Transitioning to a Nakaso-led BOJ would also facilitate a revision of the fiscal pact between the government of Prime Minister Shinzo Abe and the central bank, paving the way for an expansion of the budget, and, if needed, another postponement of the second hike in Japan’s consumption tax rate, from 8% to 10%, that is currently slated for October of 2019.

Just five years ago, on January 22, 2013, the BOJ and Japanese government, represented by the Cabinet Office and Ministry of Finance, issued a joint statement vowing the BOJ would stimulate the economy from the monetary policy side, while the government would pledge to pursue a sound budget.

Specifically, the statement read, “… in strengthening coordination between the Government and the Bank of Japan, the Government will steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management.”

While that compact was made at the tail end of the tenure of Masaaki Shirakawa as BOJ Governor, it was solidly supported and embraced by his successor, Kuroda. Kuroda, himself a career MOF official, has made no bones about his endorsement of fiscal rectitude, including in the public debates over the implementation of consumption tax hikes that Abe, in fact, chose to postpone.

Nakaso – or for that matter any BOJ governor without a MOF pedigree – would ease the path for a revision of the joint statement, and for the Abe cabinet to consider an expansion of the budget. In this context, another postponement of the last scheduled leg of the consumption tax hikes becomes again possible, if not likely.

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