Bank of Japan governor Haruhiko Kuroda must feel relieved as attention has turned away from sharply rising bond yields and a sharp set-back in the Nikkei to bad Federal Reserve communication and market turmoil in China. And I am sure that he like me have noticed that Nikkei has outperformed most major global stock markets in recent weeks. That could seem like a vindication of BoJ’s policies and to extent it is. However, I would cautious against too much optimism. Kuroda still needs to work on this communication.
Two things have been notable about the recent global financial turmoil in regard to Japan. First, as mentioned the Nikkei as outperformed other major global stock markets. Second, the yen has not strengthened nearly as much as it “normally” would have done in a situation of a sharp increase in global risk aversion. This could indicate that investors expect the BoJ to offset any shock to Japanese aggregate demand from global factors. That is good news and an indication that the BoJ has gained some credibility.
However, all it not well. The BoJ is targeting 2% inflation so that is really the only true measure we can use to judge BoJ’s success. Judging from inflation expectations the BoJ is still far away from having been successful. In fact if anything we are only half way there and as global inflation expectations have dropped back recently so have Japanese inflation expectations.
Last week we got the news that the Japanese government will resume the issuance of inflation-linked bonds. That is good news because I strongly believe that that is the most important communication and policy instrument available to the BoJ. Now the BoJ should start using market expectations for inflation a lot more actively in its communication. Mr. Kuroda should not waste any opportunity to say “while we have made progress in fighting deflation inflation expecations are still well-below our 2% inflation and we will do everything to push up inflation expectations until the markets price in 2% inflation on all relevant time horizons”. In fact this is more or less the only thing Mr. Kuroda needs to say.
Similarly regarding the recent “China turmoil” Mr. Kuroda should note that “we have noticed the recent turmoil in global markets and that has put downward pressure on global inflation expectations. We will obviously do everything to offset any negative impact on Japanese inflation expectations.”
Obviously I don’t think an inflation targeting regime is optimal and I would much have preferred that the BoJ had been targeting the NGDP level. However, given the inflation target the BoJ needs to make the best of it. Therefore, Mr. Kuroda should continue to repeat the message to markets: “We target 2% inflation so that is what markets should expect us to hit”.
PS it is obvious that communication is not everything and if the uptrend in inflation expectations is not resumed soon the BoJ should clearly signal a willingness to step up quantitative easing.