In a news conference announcing plans to once again delay a consumption tax hike, Prime Minister Shinzo Abe referred to his economic policy mix, stressing that he would "rev the Abenomics engine to its full extent." He added that he would once again release the "three arrows" of Abenomics -- credit easing, fiscal spending and structural reforms -- with strength.
Delaying an increase in the consumption tax and boosting expenditure to stimulate the economy falls under the second arrow of Abenomics. In his news conference, Abe did not directly refer to the first arrow -- the fiscal policy of the Bank of Japan (BOJ). But if "full mobilization of all policy measures" goes ahead, politicians could step up their demands for additional easing by the central bank -- an unsettling prospect.
From the outset, quantitative and qualitative monetary easing by the BOJ reinforced the full-capacity operation of the Abenomics engine. This weakened the yen and led to large increases in company profits and stock prices, but the situation had clearly been approaching an impasse.
So now, the strategy seems to be to boost the output of public finance. But we cannot necessarily conclude that monetary policies have halted.
Cabinet Secretariat adviser Etsuro Honda, who is close to Abe, was quoted in the Wall Street Journal as saying that the BOJ could implement additional monetary easing in June. He suggested that the BOJ could raise its annual asset-purchase target to 100 trillion yen a year, significantly higher than now. The BOJ currently purchases government bonds so that their amount outstanding will increase at an annual pace of 80 trillion yen. Honda describes the move as additional easing to implement an "upgrade" of Abenomics. But if the government raises expenditure without financial backing while the central bank increases purchases of government bonds, then the BOJ will be lumped with the role of being a source of finances.
To avoid such a situation, the BOJ and Japanese government made a promise in their joint declaration of January 2013. In exchange for accepting an annual 2 percent inflation target, the government stated in a document that it would work on restoring the health of the nation's finances and on structural reform.
But while the BOJ, with its eyes on this target, introduced additional quantitative easing and a negative interest rate policy, the government decided twice to put off increasing the consumption tax -- a move that only worsens public finances.
Will the BOJ close its eyes to the government's neglect of its promise and continue to take part in endless fiscal expansion with additional monetary easing? Or will it instead switch to a flexible policy without getting caught up in achieving the 2 percent inflation target in a short period of time, steering to a goal of reducing quantitative easing in stages?
The prime minister postponed the consumption tax hike as a "new decision." Now would probably be an opportune time for the BOJ, too, to make a "new decision" and introduce a shift in its policy.
If the BOJ chooses to align itself with the government and go down the path of revving up government policies, then it could completely lose its independence as a central bank. If inflation progresses and the BOJ wants to tighten its policy, it will probably become impossible to do so. The BOJ should be keenly aware of the danger of becoming a "magic mallet" for the government that can hammer out anything.