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Risks in Japan's monetary policy
Tue, 4 Jun Pre-Open

Loose monetary policies to promote growth have their own share of problems. While softening interest rates reduce cost of capital and promote growth cheap liquidity also creates inflationary pressures in the economy. Now as long as liquidity created via money printing stays within the country's borders there is no impact on the other economies. However, if this money strays outside the country's borders it has potential to create asset bubbles in other parts of the world.

This is the prime worry with Japan's loose monetary policy now. It is believed that Japan's expansionary policy is likely to de-stabilize its neighboring countries. That's because the cheap money created in Japanese system is now finding its way into world markets. Japanese being net buyers of foreign stocks is a reflection of this fact.

However, the most worrying factor arising from this loose monetary policy is its effect on currency markets. It may be noted that Japanese yen has depreciated by more than 20% during the current year. This has made Japanese goods more competitive in foreign markets. And this has negatively impacted the countries that have the same export markets as Japan.

One thing to note is that despite keeping interest rates near zero Japan has been facing a deflation problem. So, it is natural for the Japanese central bank to inject further liquidity into the system so that the country comes out of this situation. But what is happening is that the cheap liquidity created by the central bank is finding its way into other markets.

Capital chases growth. This is a universal fact. And this is the reason why despite undertaking liquidity injection, Japanese markets are not seeing asset prices rise. The reason is simple. Investors don't see much growth in Japan. Hence, they are reluctant to invest there.

It may be noted that any monetary or fiscal tool is good to stimulate the economy only if growth prospects of the economy are bright. Simply running fiscal deficits or resorting to cheap monetary policies will not help the economy in the long run. And Japan should understand this.

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