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Central Bank Chiefs Reluctant to Follow Japan

Haruhiko Kuroda, governor of the Bank of Japan
Haruyoshi Yamaguchi | Bloomberg | Getty Images
Haruhiko Kuroda, governor of the Bank of Japan

When a conservative central bank describes its policy shift as "massive", there can be little doubt about the revolution in Japanese monetary policy.

This enormous shift will fascinate the rest of the global central bank community, as Japan's feeble economic performance is often seen as the canary in the coal mine – a warning of the consequences of repeated policy mistakes.

The immediate response on Thursday from two of the largest – the European Central Bank and the Bank of England – showed a complete lack of international co-ordination. The BoE kept policy unchanged and issued no statement, while Mario Draghi, ECB president, said his institution was "ready to act" but did not feel that any additional monetary stimulus was yet warranted.

(Read More: The Buck Does Not Stop With ECB: Draghi)

The reluctance to follow Japan's lead partly reflects the special circumstances of Japan's economy.

Unlike any other large economy, Japanese nominal gross domestic product – the cash value of money spent on goods and services – was lower in 2012 than 20 years earlier, as gains in the volume of output were offset by falling prices.

The victory of deflation over Japan's moderately loose monetary policy has often been attributed to a conservatism in Tokyo not shared by other central banks since the 2008 financial crisis.

Most European and American central bankers feel Japan is catching up with their steely efforts to maintain low, but positive, inflation rates during the recent years of sub-par economic performance. Although nominal GDP growth in the US, eurozone and the UK has been disappointing over the past three years, deflation has been conspicuous by its absence.

(Read More: Bank of Japan Policy Is Huge, Risky Experiment)

So confident is the Federal Reserve that it has now succeeded in shifting US sentiment that John Williams, the dovish president of the San Francisco Fed, this week predicted it would start reducing its money-printing and asset-purchasing operations this summer. "If all goes as hoped, we could end the purchase program some time late this year," he added.

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Outside the immediate monetary policy parallels, however, the Bank of Japan's move is much more significant, showing Haruhiko Kuroda, the new governor, and Shinzo Abe, prime minister, to be in the vanguard of policy thinking on central bank independence and the limits of monetary policy.

The BoJ's move also signals a victory for elected politicians in a long battle over the optimal degree of central bank independence. Japan has now settled on the view that government sets the parameters for a central bank – an end to deflation and a 2 per cent inflation target – and then expects the technocrats to meet these objectives.

Jens Weidmann, the Bundesbank president, warned in January that such action was "threatening to end central bank autonomy" because "the new [Japanese] government is massively involving itself in the affairs of the central bank".

But his view is increasingly rejected across the world, as politicians demand that central banks act more aggressively to meet their given mandates.

A similar move occurred in Britain in last month's Budget when George Osborne, chancellor, ordered the Bank of England to consider how it could follow the Fed in using new, unconventional tools – such as making a commitment to keep interest rates low so long as unemployment remained high – in order to meet his goal of combining "monetary activism with fiscal responsibility".

(Read More: UK Needs 'Monetary Realism': Ex-BoE Official)

If the BoJ's independence is now clearly defined as operational rather than absolute, it has also signalled that it is willing to use its powers to test to destruction the view that it still has power to influence the economy and inflation.

Japan's monetary base – notes and coins in circulation alongside electronic money – is now set to rise to 55 percent of national income, far above the levels in the US and eurozone, which sit comfortable below 20 per cent. The BoJ now "stands out among major central banks" in its willingness to throw much more ammunition at its deflation problem, according to Kyohei Morita, of Barclays, and this view is gaining some influential supporters.

(Read More: BOJ Throws In Kitchen Sink in War With Deflation)

Much recent rhetoric from the Bank for International Settlements and other central bankers has stressed the limits to monetary policy in boosting economic growth when weakness is caused by the more fundamental hangover from the financial crisis. "Printing money is not . . . simply manna from heaven," Sir Mervyn King, governor of the BoE, said last October.

However, he has more recently come round to the need for more monetary action in Britain, while Mr Draghi hinted on Thursday that the ECB was also close to changing its mind.

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