EDITORIAL: Financial policies

In a deflationary spiral, prices of goods and services go into a tailspin, trimming sales revenues, lowering production and shrinking payrolls at companies. In times like that, the economy as a whole continues to shrink, pushing down prices further. In light of the state of the domestic economy, it will have to keep walking, at least for the time being, on the brink of falling into a dreadful downward spiral.

The Bank of Japan, in its latest report titled "Outlook for Economic Activity and Prices," said prices will keep falling through fiscal 2011. It said the economy will likely start growing again in fiscal 2010 on the back of increased exports to emerging economies, gradually decreasing the margin of decline in prices.

But it is by no means certain that this rather rosy scenario will come to pass. There is no room for optimism at the moment.

After the collapse of the asset-inflated economy in the early 1990s, Japan became the first industrial nation since the end of World War II to experience deflation. Now, the threat of full-blown deflation is growing again in the aftermath of the global economic crisis. Japan has yet to emerge fully from the situation where falling prices of a broad range of goods and services are putting a strain on its economy.

Policymakers need to take utmost care to prevent the economy from tumbling into a deflationary spiral.

Deflation is caused by a shortage of overall demand. The only effective remedy for deflation is a mix of fiscal and monetary expansion to stimulate the economy. It is, however, important to combine such economic stimulus measures with steps to nurture new industries and create jobs based on a strategy for medium- and long-term economic growth. Simply trying to relieve a demand shortage won't be enough.

Meanwhile, the central bank has announced that it will phase out part of the measures to support corporate financing it introduced following the failure of U.S. investment bank Lehman Brothers in September last year. The BOJ will terminate its program to purchase commercial paper, a short-term unsecured promissory note, and corporate bonds at the end of this year.

As applications for the program have fallen sharply in recent months, the central bank has decided the program is no longer necessary. The BOJ has also decided to close at the end of March a special lending program to provide financial institutions with unlimited funds for corporate lending. Under this program, the BOJ extends loans to banks at an annual interest rate of 0.1 percent, securing corporate bonds submitted to the central bank and other debt securities as collateral.

These decisions reflect receding concerns about the serious credit contraction that temporarily made it hard even for large companies to raise funds. If, however, the economy falls into a second bottom, the central bank should not hesitate to revive these measures. Flexible responses to changing economic conditions are vital.

Market players should not regard these moves as the beginning of a so-called exit strategy, which means ending the extremely easy monetary policy that is now in place.

As the improved earnings results for the first half of the current fiscal year have indicated, large companies are beginning to recover. With industrial production still at a low level, however, small and midsize companies remain stuck in dire straits. A significant increase in bankruptcies among them could prolong this deflation and recession.

Concerns about the crisis among small and midsize firms have prompted the government to submit a bill to the extraordinary Diet session to help ease their financing difficulties. The BOJ has also pledged to maintain easy credit conditions tenaciously, suggesting it intends to ensure that funds will be flowing from financial institutions into small and midsize businesses.

To prevent the economy from slipping into a double-dip recession, policymakers should make every effort to support the financing of smaller businesses while enhancing measures to create jobs.

We hope the government and the BOJ will work together to take effective policy measures to save the economy.

--The Asahi Shimbun, Nov. 6(IHT/Asahi: November 7,2009)