Why Japan's Latest Attempt to Boost Its Economy Won't Work

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Yoshikazu Tsuno / AFP / Getty

A businessman passes before a share prices board in Tokyo.

After weeks of calls by the Japanese government to do something about deflation and the fast appreciating yen, the Bank of Japan held an emergency meeting Tuesday — and decided what the world's second largest economy needs is more money. Central bank governor Masaaki Shirakawa announced steps to step up monetary easing by injecting 10 trillion yen (about $115 billion) into Japan's financial system. Shirakawa told reporters that these steps could be considered "quantitative easing in a broad sense." The eight-member policy board also unanimously voted to maintain the Bank of Japan's key short-term interest rate at 0.1%. Doubts, however, remain about what the boost to liquidity will actually achieve.

A move toward quantitative easing has been expected in recent weeks, as Japan's Prime Minister Yukio Hatoyama and his administration have pressed the central bank to take steps to contain deflation, prevent another downturn in the economy, and to tame the runaway yen, now at 86 yen to the dollar compared to 93 a year ago. On Nov. 27, the dollar fell to a 14-year low against the yen, triggering concerns that the currency could start to unravel progress that stimulus spending has made on the economy this year, in part by wreaking havoc on export competitiveness.

On Tuesday, Deputy Prime Minister Naoto Kan, who is also the national strategy chief, and Finance Minister Hirohisa Fujii, stressed the importance of quantitative easing to the Bank of Japan. In turn, the Bank agreed to cooperate by lending 10 trillion yen, in the form of short-term loans, to commercial banks at the rate of 0.1%, and to accept government bonds and corporate debt as collateral.

But Shirakawa has previously said that it was not the lack of liquidity in Japan's economy, but the lack of demand that is behind the economic situation. On Nov. 20, the day that Hatoyama acknowledged deflation, Shirakawa said, "We need to work on the core reason for [deflation]: weak final demand as seen in capital investment and private consumption." Economists estimate Japan's demand shortage at around $400 billion a year.

With demand so low, few firms will be willing to borrow which means the impact of another round of easing is likely to be limited. Masaaki Kanno, JPMorgan Securities chief economist in Tokyo, says, "The message from senior [Democratic Party of Japan] politicians is that they want the BOJ to implement quantitative easing. And this is the answer from the BOJ — reactive rather than proactive." Kanno says that the BOJ is making a kind of concession to the government and is probably reluctant to implement quantitative easing because it is not convinced that it will improve deflation, economic stagnation or the unemployment rate. "I don't think the BOJ expects improvement on those fronts," he says. "This does no harm, but it does no good."