The case for Fukui: a long-time Tokyo observer argues why a reformer, and not a deflation fighter, is Japan's best bet

International Economy, The, Spring, 2003 by Richard Katz

It is hard to see how Japan can revive unless reformers are put in charge of key policymaking institutions. That is why the appointment of Toshihiko Fukui as governor of the Bank of Japan is a positive step.

Like Masaru Hayami, his predecessor, the 67-year-old Fukui is a veteran BOJ official who believes that printing money cannot substitute for thorough reforms. As he told the Asahi Shimbun, "It is wrong to think that the current deflation can be stemmed through monetary easing alone ... Structural reforms are more important than ever before." The top priority is dealing with the horde of "zombie borrowers," Fukui explained to Bloomberg, "Those borrowers that should leave the market still remain and exacerbate deflation and harm the profitability of the healthy."

The limited impact of monetary easing is recognized even by many of those who press the BOJ to conduct more "unconventional stimulus." Consider this statement: "Unless banks make progress on bad-debt disposal, the monetary easing by the Bank of Japan will not produce results, making it impossible to beat deflation." It sounds like the BOJ, but the actual speaker was Heizo Takenaka, the minister for both economic policy and financial services. How about this one: "Neither monetary policy nor banking policy can fully succeed without the other in achieving the goals of strong economic growth." That's the message delivered in Tokyo last November by John Taylor, a renowned monetary economist now serving as the U.S. undersecretary of the Treasury. And finally: "Policy measures to strengthen [Japan's] banks are a prerequisite to restoring the effectiveness of the monetary transmission mechanism." That comes from IMF economists in their book, Post-Bubble Blues.

Given the slowness of government efforts on the banking problem, the next few years will bring neither recovery nor cataclysm, but continued malaise.

There is, of course, an alternative view. Some still harbor the futile hope that massive money-printing, like the government's spending on "bridges to nowhere" in the past, can substitute for reform. Critics claim that the BOJ could create 3-4 percent inflation at will and that this inflation would, in turn, revive private demand. Some even suggest that the BOJ buy up assets used as collateral for bank loans, from corporate equities to office buildings.

While many economists support such measures, the most fervent advocates are the opponents of reform. They hope that higher stock and property prices can make bad loans good without painful restructuring of "zombie" borrowers. The more Japan's leaders grasp at monetary straws, the less likely they are to undertake true reform.

Indeed, as of deadline time in mid-March, anti-reformers were exaggerating the dangers of an alleged "March crisis," i.e., yet another fall in the stock market, to justify their case. Arguing that various accounting and banking reforms were hurting stock prices, they called on the government to reverse them. They also amplified past calls for the BOJ to buy stocks and real estate. In the panicky atmosphere, these calls on the BOJ were joined even by some of those who had supported Fukui, such Hiroshi Okuda, chairman of both Toyota and the Keidanren business federation. While Takenaka has so far opposed any reversal or delay of the banking reforms, he has unfortunately joined the pressure on the BOJ. Fukui is likely to resist a simple bailout, while looking for something the BOJ can do.

WHAT FUKUI WILL DO

In his basic philosophy, Fukui represents continuity with Hayami. However, even Fukui's critics acknowledge that he possesses greater political acumen, more flexibility, and a denser network of supporters in politics and business. Consequently, say BOJ officials, Fukui could be more effective than Hayami in building consensus for reformist policies.

Fukui wants the BOJ to exert a direct impact on the bad loan problem, possibly through its bank examination authority. The BOJ cannot legally enforce its findings but it can turn a brighter spotlight on problems. In addition, he wants to find new ways to add liquidity. Options under discussion include an increase in purchases of Japanese government bonds (JGBs), asset-backed commercial paper, and perhaps Exchange Traded Funds (i.e. stock market index funds). How the latter squares with Fukui's opposition to artificial support for stock prices is unclear. On the other hand, Fukui is hesitant to buy foreign bonds in order to depreciate the yen.

To a large extent, the BOJ's hands are tied. It can refuse the most outrageous bailouts, like buying buildings. But it cannot force the government to institute structural reform. Regardless, the BOJ has no choice but to keep the financial system stable. It can, and will, keep long-term interest rates on the floor while ensuring that the banks stay liquid. Unfortunately, the government keeps using these easing measures, not as breathing space to weed out the zombies, but as fuel to sustain them. The BOJ ends up being an "enabler" for the very policies it decries.