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Japan needs to stick to a consistent policy and its central bank must be more effective in communicating its policy if it is to defeat the country's deflationary conditions, the International Monetary Fund said in a paper released on Monday.
The IMF paper, which is put together by its staff members, calls for policy predictability and credibility in order for the central bank to impact long-term interest rates, anchor inflation expectations and reduce asset price volatility. It also pushes Japan to set a wage inflation goal of around 3 percent in order to end low wage growth and for prices to increase in line with the bank's inflation target of 2 percent.
"The adoption of an explicit inflation target in January 2013 constituted a major advance in transparency….However, after three years, the need for stronger communications, as part of a more effective strategy, is suggested by the fact that the economy remains in a dark corner, with interest rates at their floor, and long-term inflation expectations well below the 2 percent target," the paper said.
The paper proposes a comprehensive policy package to get the Japanese economy to a higher sustainable growth path and end deflation. Referring to it as 'Three Arrows Plus' – monetary, fiscal, structural and income policies – the paper looks at how coordination of these policies could have maximum impact of success.
"An unorthodox component of the package is an incomes policy aimed directly at sluggish wage-price dynamics. We build on the authorities' current policies by emphasizing the need for more credible and transparent monetary and fiscal frameworks that reinforce each other to reduce policy uncertainty and raise policy effectiveness," the paper said.
Abenomics was introduced in 2013 in an effort to break Japan's economy out of a decades-long deflationary spiral. The program, which was expected to include three "arrows," began with a first arrow of massive quantitative easing from the BOJ. It was followed by plans for increased government spending. But the third arrow of structural reforms, including immigration and labor changes, has disappointed expectations. A number of analysts have pointed to the need for overhaul of all three measures.
The IMF working paper said reforms to these arrows would positively impact growth. "Although their short-term effects are uncertain, over time such reforms would raise the growth rate of potential output."
Japan has been trying to balance its monetary and fiscal policies in order to stimulate growth. The country recently approved a $274 billion stimulus package in fiscal measures aimed at reviving the country's ailing economy.
Prior to that, the Bank of Japan announced a modest rise to its monetary stimulus by increasing the amount purchases of exchange-traded funds (ETF) it buys. The bank however maintained its base target as well as the pace of purchases for other assets including Japanese government bonds. It also left interest rates unchanged at 0.1 percent. The central bank plans to conduct a comprehensive review of its easing program at its next policy meeting on September 20.
"Monetary policy would need to continue to be managed flexibly with all easing options remaining on the table to respond to demand conditions in the economy," the paper said, adding that the objective would be to plan for a modest overshoot of the long-term 2 percent inflation target in order to get the economy permanently out of the effective lower bound.
"If the response to fiscal or incomes policy or structural reforms is stronger/weaker than expected, monetary policy would need to adjust flexibly to provide less/more stimulus as needed in order to ensure the attainment of the inflation target over the medium term."
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