The Bank of Japan (BOJ) has adopted a 2 percent inflation target and an open-ended asset purchase program in its latest effort to boost economic growth and wrest the country from almost two decades of a deflationary slump.
The BOJ's additional monetary easing, along with a joint statement with the government, was widely expected following intense pressure from the new government under Prime Minister Shinzo Abe which has approved fresh stimulus spending of more than 20 trillion yen.
Under the new "open-ended asset purchasing method," which starts January 2014 when the current 101 trillion yen asset purchase program expires, the BOJ will buy some 13 trillion yen of assets every month: About 10 trillion of treasury bills and about 2 trillion of JGBs, or Japanese government bonds.
The BOJ's new 2 percent inflation target is in line with most other major central banks, including the Federal Reserve and the European Central Bank, and replaces its previous "goal" of 1 percent inflation with a "target," a move it hopes will raise the inflationary expectations of households and firms.
"The Bank will pursue aggressive monetary easing, aiming to achieve the above-mentioned price stability target, through a virtually zero interest rate policy and purchases of financial assets, as long as the Bank judges it appropriate to continue with each policy measure respectively,"the BOJ said.
"Going forward, as prices are expected to rise moderately, it is judged appropriate to clearly indicate the target of 2 percent in order to anchor the sustainable rate of inflation," it added.
Another reason for switching to a "target" from a "goal" is the growing awareness of the need for flexible monetary policy that also takes into account the risks of financial imbalances, BOJ said.
"Such understanding has been widely shared around the globe; particularly, in the aftermath of the global financial crises, major economies of the world have come to emphasize flexibility in the conduct of monetary policy - by, for example, publicly articulating the importance of paying due attention to financial system stability," the BOJ said.
The BOJ's reference to financial system stability reflects the emergence of a new paradigm for monetary policy worldwide. Instead of purely relying on inflation targets to determine interest rates, central banks are starting to look at other measures, such as household debt, to help set policy.
"Taking into consideration that it will take considerable time before the effects of monetary policy permeate the economy, the Bank will ascertain whether there is any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances,"the BOJ said.
As part of its operational guidelines for money market operations, the BOJ also held its benchmark overnight call rate steady at 0-0.1 percent, unchanged since 2010 when it launched its asset purchase program and lowered the call rate from a previous goal from 2008 of 0.1 percent.
The need for aggressive easing was illustrated by the BOJ's economic assessment in which growth forecasts were lowered for fiscal 2012 from last October's economic outlook. For fiscal 2013 forecasts were raised slightly due to the government's stimulus measures while 2014 forecasts were steady.
"Regarding risks, there remains a high degree of uncertainty concerning Japan's economy, including the prospects for the European debt problem, the momentum toward recovery for the U.S. economy, the possibility of emerging and commodity-exporting economies making a smooth transition to the sustainable growth patch, and the effects of the recent bilateral relationship between Japan and China," the BOJ said.
The Joint Statement that was issued by the BOJ and the Japanese government underscored the renewed efforts to overcome deflation as fast as possible. While the BOJ is responsible for price stability, including hitting the new 2 percent inflation target, the government will take action to strengthen the country's competitiveness and growth potential.
"Those measures include all possible decisive policy actions for reforming the economic structure, such as concentrating resources on innovative research and development, strengthening the foundation for innovation, carrying out bold regulatory and institutional reforms and better utilizing the tax system," the joint statement said.
Japan's inflation rate turned negative in the mid-1990s and consumer prices have largely remained negative since then despite repeated efforts by governments and the BOJ to ignite inflation.
In November, Japan's inflation rate was minus 0.2 percent, the sixth month in a row of deflation, while Gross Domestic Product only expanded by an annual rate of 0.5 percent in the third quarter, down from the second quarter's growth rate of 3.9 percent.