A better way to fight deflation - Haruhiko Kuroda should give Bob Hetzel a call

A better way to fight deflation - Haruhiko Kuroda should give Bob Hetzel a call
Haruhiko Kuroda has been nominated new governor of Bank of Japan. His job description is simple - take Japan out of 15 years of deflation and hit the BoJ's new 2% inflation target. Contrary to most observers I think Kuroda has a real easy job. He can easy hit the 2% inflation. All he has to do is to give Robert Hetzel at the Richmond Fed a call. Bob will surely tell him about one of his old ideas that will ensure that BoJ will hit the 2% inflation target. In 1991 Bob wrote a pathbreaking article in the Wall Street Journal on "A better way to fight in inflation". In the article Bob makes the following suggestion:
"The Treasury (should) be required ...to divide its issue of bonds at each maturity into a standard bond and an indexed bond. Interest and principal payments on the index bond would be linked to a price index. The Treasury would be required to issue the two forms of bonds in equal amounts.  The market yield on the standard bond, which makes payments in current dollars, is the sum of real (inflation-adjusted) yield and the rate of inflation expected by investors. The market yield on the indexed bond, which pays interest in dollars of constant purchasing power, in contrast, would simply be a real yield. The difference in yields on the two kinds of bonds would measure the inflation investors expect over the life of the bond"
Bob goes on to explain his proposal:
"The long lag between monetary policy actions and inflation means that it is difficult to associate particular policy actions with the rate of inflation. Changes in expected inflation registered in changes in the difference in yields between standard and indexed bond would provide an imitate and continuos assessment by the market of the expected effects on inflation of current monetary policy actions (inactions). A market measure of expected inflation would constitute a useful restraint on inflationary policy. Fed behavior judged inflationary by the market would produce an imitate rise in the yields on the standard bonds and an increase in the difference between the yields on the standard and indexed bonds.
In the context of Japan I am sure that Bob would advice Kuroda to announce that the BoJ would "peg" the difference between  


WORLD LEADING ADVISORY SPECIALISING IN THIS TOPIC

GET NEWSLETTER

Sign up now to receive the latest blog posts and news about our research.