Japan is about to test the limits of what bolder monetary policy can achieve in a stumbling economy when interest rates are already at zero, deflation expectations have become entrenched after years of price declines and previous bond-buying binges have barely made an impact.
That the Bank of Japan will be pushed to set aside its traditional conservatism and tread into uncharted waters was ensured Thursday with the government's nomination of Haruhiko Kuroda, president of the Asian Development Bank, as the central bank's next governor.
Prime Minister Shinzo Abe has turned to Mr. Kuroda, 68 – and equally dovish academic Kikuo Iwata, a strong critic of previous bank policies, as one of his deputies – largely because of their shared view that a more aggressive monetary policy could help stimulate growth, weaken the yen and arrest nearly two decades of crippling deflation.
"The government's thinking about monetary policy has probably never influenced nominations of the BoJ governor this strongly before," Chotaro Morita, Barclays Capital Japan chief rates strategist, said in a note, adding that any central bank decisions "that run counter to the government's intentions will probably fail to win acceptance."
Mr. Kuroda, a graduate of Oxford and Tokyo universities, certainly has the requisite credentials for the job. He spent much of his career dealing with tax and currency matters in the powerful Ministry of Finance, where he was properly indoctrinated in the primacy of finance bureaucrats in all monetary matters. He rose to become vice-minister for international affairs, the job he held when the global financial system nearly collapsed in 2008. He was in charge of international currency issues during the Asian financial crisis in the late 1990s.
His front-row seat for the Asian crisis, and then the global financial meltdown, reinforced his opinion that Japan's central bank was not doing enough to lift the country out of its slump, which the crises only deepened.
The Bank of Japan must be prepared "to do anything and everything" to achieve its new 2 per cent inflation target, Mr. Kuroda said in January. He had been a staunch advocate of raising the target to as high as 3 per cent from the previous 1 per cent – although he now says 2 per cent is the right figure – and for ballooning the bank's balance sheet to pull Japan out of its deflationary spiral.
The central bank should look at "anything and any amount and any financial asset" to combat deflation, Mr. Kuroda told The Wall Street Journal.
But current governor Masaaki Shirakawa – who leaves the post March 19 – and other senior bank officials had long resisted more aggressive intervention and inflation targeting, arguing that further quantitative easing was no elixir for an ailing economy beset by deep structural problems. Previous massive money-printing efforts did little apart from exacerbating Japan's worsening debt problems.
Questions remain about how much manoeuvring room the new governor will have.
"A closer look at Mr. Kuroda's policy options suggests that the markets' expectations of significantly more aggressive easing are likely to be disappointed." said Julian Jessop, chief global economist with Capital Economics in London.
The most likely moves, at least initially – more purchases of government bonds and with far longer maturities – "would … still fall well short of the easing currently planned in the U.S.," Mr. Jessop said in a note. "What's more, some of the more radical options, including purchasing foreign bonds and setting a two-year horizon for the new 2 per cent inflation target, are unlikely to gain sufficient support."
The key to defeating deflation, economists and analysts say, lies in changing the mindset of Japanese businesses and consumers, who routinely put off purchases in the belief that prices will drop in future.