There are serious questions whether the time is right for Japan to rise its interest rates again, as this interview in the FT with Finance Minister Omi Koji by David Pilling and Martin Wolf indicates. This bit is of particular interest:
Paul Sheard, global chief economist at Lehman Brothers, said he was concerned that Japan’s economic authorities were applying the brakes at the wrong time. “The big picture in Japan is that deflation continues and monetary and fiscal policy are both being tightened,” he said. “I challenge you to find any textbook where that is described as an optimal policy mix.”
Of course, economics textbooks are far from infallible. Nevertheless, the point is a good one.
This remark is interesting in light of the Abe Cabinet’s latest push to trim the budget. Reducing Japan’s colossal deficit — in part the product of pump priming in the depths of Japan’s “lost decade” — is a necessary and long-term task for Japan’s government (previously discussed here). Because the government is committed to contractionary fiscal policy for the indefinite future, however, the BoJ must exercise extreme caution in its monetary policy decisions in the coming year. Anything more than a light tap on the brakes could bring the Japanese recovery to a screeching halt.
The data on the course of Japan’s recovery is probably too mixed at the moment to make a firm judgment as to its sustainability, and the BoJ may be acting a bit too hasty to be assuming that the next two years will see growth continue unhindered.
Politically speaking, I wonder whether Japan’s new air of confidence could survive a serious economic downturn. At the same time, though, a downturn could obviate the need to consider a consumption tax hike, about which Mr. Abe has determined no decision will be made until autumn 2007, after the Upper House elections.