BANK OF JAPAN FINDS EVERYONE IS A CRITIC

BANK OF JAPAN FINDS EVERYONE IS A CRITIC

Governor Masaru Hayami of the Bank of Japan is a tough, market-savvy veteran of many monetary and financial crises. He is personally shy but has a knack for cutting to the core of an issue and saying what he thinks.

He draws from his original career at the bank and his years in the private sector, first as chief executive of a Japanese trading company and then as president of Japan's most prestigious business leaders' group. He is the ideal person to be the first governor heading the bank now that it has been granted independence.But, boy, is he in hot water.

Everyone else in the Japanese government wants him to ease monetary policy, as do most of the officials from other countries who have expressed views on the subject.

Over the past two weeks in Japan and at the International Monetary Fund-World Bank meetings in Washington, Hayami was subjected to intense pressure to ease policy further and was vilified for not having given in already.

He finally said something that sounded like he relented, but his critics are still not satisfied.

The debate borders on the absurd. The Bank of Japan has already flooded the money market with fresh yen liquidity. Before last week, it had already pushed short-term interest rates to 0.15 percent per annum.

Last week, perhaps as Hayami's answer to his critics, the Bank of Japan was pouring even more yen into the system, driving the money market rate to 0.03 percent. (Compare that to the U.S. federal funds rate of 5.25 percent!)

The Bank of Japan is giving money away.

Over and over, the central bank has explained that it is operating in a classic liquidity trap - that the demand for money has collapsed, and that the bank's efforts to stimulate the economy through the creation of new money is like pushing on a string.

And yet, over and over, the bank's critics argue that it just isn't pushing hard enough on the string. They suggest a variety of policies. For example, they are telling the central bank not to sterilize its intervention in the foreign exchange market.

The concept of sterilized intervention is popular among academic writers of undergraduate money and banking textbooks, and is thus popular among people whose study of monetary policy stopped there.

The idea is that when the Bank of Japan intervenes to buy dollars, it does so by creating new yen. If it leaves those yen in the banking system, the intervention is said to be unsterilized.

If, however, in the course of its domestic open-market policy actions, it offsets that creation of yen by absorbing yen from the money market, then the intervention is said to be sterilized.

But the central bank is involved in a wide range of transactions each day that add to or subtract from the amount of liquidity in the banking system, and intervention is just one of them.

In the U.S. context, we don't hear debates about unsterilized swings in float or swings in Treasury balances. Monetary policy applies to the central bank's whole balance sheet.

Indeed, the reason the central bank intervenes in the exchange market these days is to establish two-way trading in that market by influencing the expectations of traders and investors.

To achieve that objective, the smaller the intervention the better. So any time you see someone suggesting that the central bank should not sterilize its foreign exchange intervention, that person is telling the central bank to ease monetary policy.

The Bank of Japan is also under pressure to intervene in the domestic bond market, buying Japanese government bonds to bring long-term interest rates down. Not surprisingly, this idea mainly comes from officials in the Ministry of Finance.

For Americans, this issue is reminiscent of the debate over Federal Reserve open-market policy in the late 1950s between advocates of ''bills only'' and those of ''bonds often.''

Bond yields are largely determined by the expectations of traders and investors, including inflationary expectations. On occasion, the central bank can influence bond yields temporarily by intervening in that market.

But long-term support of the bond market, with massive amounts of purchases, soon aggravates inflationary expectations and becomes a self-defeating exercise. Why? Because everyone recognizes that the central bank has become an engine for financing the fiscal deficit.

Monetary policy works best when it is limited to operations in the money market. Thus, and especially in the present context, the Bank of Japan's critics who press for it to support the bond market are merely asking it to ease monetary policy further.

Instead, Japan needs policies that pull on the string, that create a demand for money through stimulating consumption directly and through increasing the potential profitability of capital investments.

That's fiscal policy. And policies are what create confidence in the banking system and capital markets.

Government officials in Japan and other countries who are beating up on Hayami should address those issues rather than devoting so much energy trying to get the Bank of Japan to reduce its money market rate by another 0.03 percent.