To Print Or Not To Print, That Is The Question

Well in a week which has seen Kazuo Momma, head of the Bank of Japan’s research and statistics department warning that Japan’s economy now faces faces an “unimaginable” contraction, and Prime Minister Taro Aso's approval rating dropping to a mere 14 percent according to the latest Asahi newspaper survey, it should not surprise us to hear reports that yet another set of "exotic" proposals have been put forward in the search for ways of dragging the Japanese economy out of the mess into which it seems to have fallen.

The proposal I am referring to is the latest "initiative" being quietly cooked up by some members of the ruling Liberal Democratic party. According to reports in the Japanese press the politicians in question, who include Yoshihide Suga, deputy chairman of the LDP’s election strategy council and a close aide to prime minister Aso, have set up a working group and are quietly dusting down plans (first advocated by Nobel economist Joseph Stiglitz on a flying visit to Tokyo) for the government to introduce its own private currency - yes that's right its own currency - to run in tandem as a rival the country's already existing official one (aka the Yen) which is essentially exclusively issued by the Bank of Japan.

The plan would seem to involve the printing of some Y50,000bn ($546bn) worth of a new currency to fund government pump-priming projects and arrives at a time of rising frustration among politicians about the posture being taken by the Bank of Japan who have been notably reluctant to bow to pressure and let the yen printing presses run ever faster in a desperate attempt to stimulate the economy.

Among proposals they have on the table are Y30,000bn of the new money to fund programmes supporting new industries and infrastructure projects, including doubling the size of Tokyo’s Haneda airport. The remaining Y20,000bn would be earmarked for government purchases of stocks and real estate.

“We are facing hyper-deflation, so we need a policy to create hyper-inflation.
We have to do something to undermine the central bank and government’s
credibility or else we won’t be able to halt the yen’s rise. So, while we know
this is drastic medicine, we will do it,” said Koutaro Tamura, an upper house
Diet member who will chair the new group.

The proposals are causing all sorts of controversy in Japan. Prime Minister Taro Aso said on Monday evening that "We are not at all at the stage of considering such an idea", while Chief Cabinet Secretary Takeo Kawamura warned that if the government prints money, it could lead to inflation and weaken the yen against other major currencies. BOJ Gov. Masaaki Shirakawa was also pretty critical of the proposal, saying it could "cause great damage" to the central bank's balance sheet and monetary policy as well as market confidence in the yen.

"The plan would require very careful consideration because it could result in jumps in Japan's long-term interest rates, with market participants losing trust in the government's commitment to repaying its debts," Shirakawa said.

Of course, what may lie behind such thinking is an extremely literal reading of a very influential academic paper by IMF economist (and former Paul Krugman PhD student) Gauti Eggertsson How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible - right down to the small print. The basic idea is that as expectations of intensifying deflation set in deeper and the economic contraction intensifies a short sharp shock of irresponsibility is needed to convince people that inflation is inevitable.

Weakening the yen, and raising market participants inflation expectations (or their fear that government will irresponsibly monetise its debt), is just what the Eggerston proposal is all about, so fears of such an outcome - as expressed above - would hardly seem to constitute objections, and while it is unlikely that the plan will get very far in the short term (rather than prodding the BoJ into more aggresive action), Japan's crisis is very severe, and getting worse by the day, so clearly they are something out of the ordinary needs to be considered.

Industrial output plunged by a record 9.6 per cent month on month in December,and the consensus opinion among economists suggests GDP may have fallen more than 3 per cent compared with the previous quarter at the end of 2008 – an annualised decline of over 12 per cent.

“From October to December the scale of negative growth [in GDP] may have been unimaginable – and we have to consider the possibility that there could be even greater decline between January and March,” Mr Momma said in a speech.

So perhaps the unimaginable in negative growth may also call for what would previously have been unimaginable policy as a response.