Well that’s disappointing. After a lot of thought that the Bank of Japan would preemptively yield to new Prime Minister Shinzo Abe’s desire for a 2 percent inflation target, the bank instead today totally punted. Their new policy statement suggests perhaps a long-term goal of 2 percent, but continues to forecast 0.4 percent inflation for 2013 and its 2014 forecast is up to 0.9 percent from a previous level of 0.8 percent.
We’ve recently seen here in the United States that a central bank can elevate short-term inflation expectations without causing long-term expectations to become unmoored. The BOJ has essentially done the reverse. Not explicitly slapped Abe’s proposal down, but ensured that in the short-term nothing will change.
The yen is rising on the news and the Nikkei is falling, an indication that Abe was right and that blockage of his proposals is bad for the Japanese economy. The forward outlook now hinges less on economics than on Japanese politics, about which I know nothing. Does Abe have the political clout to strong-arm the bank and get his way. Or can the bank take advantage of perennial fractiousness in the Japanese parliament and essentially wait Abe out? Threatening a central bank’s independence is essentially an Omar Principle situation—if you come at the king, you’d best not miss. A central bank that decides it wants to make an elected government look bad can easily tank the economy ahead of elections and count on confused voters to blame incumbent elected officials.