As the European Central Bank and Bank of England consider tightening monetary policy, HSBC Holdings Plc and Fathom Financial Consulting warn officials risk misjudging the inflation threat and may end up hurting their recoveries. That is what has repeatedly happened in Japan in the past 25 years as policy makers constrained credit only to reverse within months when expansion faltered.
“The danger is of a policy mistake,” said Stephen King, HSBC’s chief economist and a former British Treasury official. “In an attempt to control inflation this year they could set the scene for more disappointing growth in the future as happened in Japan.”
Japan’s woes, which began with the bursting of an asset bubble and extended beyond the Lost Decade of the 1990s, were a reference for central banks seeking to avoid its errors when battling the credit crisis. Ben Bernanke, current chairman of the US Federal Reserve, said in 2003 Japan’s “performance is due almost entirely to a very poor monetary policy”.
Now some are looking to its track-record on withdrawing stimulus, with British policy maker Adam Posen saying last month that colleagues should learn from Japan’s 2000 interest-rate increase, which “led to bad macroeconomic outcomes”.
“Monetary accommodation can help the recovery and tightening can undercut a nascent recovery, which is what happened in Japan,” said Daniel Leigh, an IMF economist.
HSBC’s King draws parallels with the early 1990s, when the Bank of Japan more than doubled its key rate to 6% as an oil-price surge during the Gulf War pushed inflation as high as 4.2%.
Governor Yasushi Mieno then had to backtrack as inflation evaporated, slashing the benchmark to less than 2% by the end of 1993.
Nobel Prize-winning economist Joseph Stiglitz warns fiscal policy makers are also ignoring Japan. Britain is imposing the biggest budget squeeze since World War II and raised its value-added tax to 20% from 17.5% in January. Euro-area nations spooked by the debt crisis are embracing austerity.
To Stiglitz, that echoes Japan’s 1997 effort to balance its budget, which included a two percentage point increase in the consumption levy now blamed for renewing recession.
“Europe is really facing exactly the same kind of risk,” he said.
Concern that constraining monetary policy spells a Japanese redux is not without high-level support. The Bank of England’s Posen said last month that Japan’s 2000 preemptive strike against inflation dealt a “significant blow” to policy makers’ credibility that “further de-anchored inflation expectations”.
“I am not forecasting that a tightening of policy now by the Monetary Policy Committee (MPC) would lead to deflation in the UK, though I would not rule that out,” said Posen.
“I am arguing that it would be a similar mistake for the MPC to try to prove its counter-inflationary toughness just for the sake of chatter about rising inflation expectations.”
Almost three years after the ECB raised its key rate only to cut it three months later as the credit turmoil deepened, Trichet now says a rate increase is possible in April after inflation broke the ECB’s 2% limit in December.
British inflation has accelerated to 4.4% and the Bank of England said this week there is a “significant risk” it will exceed 5% in the coming months. Policy maker Andrew Sentance said failure to act now “risks a more abrupt and destabilising” rate increase later.