Intervention Talk Goes for Naught in Japan

Tokyo was alive with talk of 'unsterilized intervention,' but the Bank of Japan stood pat.
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TOKYO -- In the end, all the intervention-inspired hand-wringing was for naught.

The

Bank of Japan

confounded markets, confused pundits and embarrassed one or two academics Tuesday when its widely watched policy meeting ended with no change. The decision came after a week of increasingly shrill voices calling for Japanese central bankers to break with modern banking tradition and leave the yen used to buy dollars during currency-market interventions in the economy, a practice known as unsterilized intervention.

The decision caught the central bank in a bind. The yen is climbing -- it rose 1.5% to about 104 yen to the dollar in the hours immediately following the announcement -- which could derail the nation's fragile recovery from its worst recession since Douglas MacArthur served as Japan's

shogun

. But the BoJ worried that by adopting unsanitary practices while meddling in the markets, it would damage its future credibility.

"The BoJ has learned valuable lessons from the bubble years that connecting monetary policy to exchange rates risks getting policy wrong," the central bank said in a statement, referring to the period of soaring asset prices that characterized the late 1980s and which some say resembles the U.S. right now. "The central bank cannot take a policy that it cannot explain fully regarding its purpose and effectiveness."

Unsterilized interventions work their magic through one of the most basic economic principles: supply and demand. Rather than sopping up the increased yen supply through open-market operations, central bankers under this model leave those extra yen in the market. Greater supply of any commodity, currencies included, without a corresponding rise in demand leads to lower prices. And you thought economics was hard?

The effectiveness of unsterlized intervention, which

Massachusetts Institute of Technology

Professor Paul Krugman called for in a speech Monday in Tokyo, has also come into question. If the bank spent $1 billion on intervention, for example, would that additional money really move a $4 trillion economy?

Some observers, however, suggested the BoJ was more concerned with its appearance than the economy. After its hard-fought battles to gain independence, central bankers were likely unwilling to allow even the appearance that they were being guided, especially after Finance Minister Kiichi Miyazawa lobbied with BoJ Governor Masaru Hayami and dispatched a high-level envoys to the U.S. last week.

"This just proves that Japan has no charismatic leader that can pull the nation out of this mess," says Shinya Seno, an analyst at

Daiwa SB Capital Markets

who worries central bankers may have missed an opportunity to help ensure the recovery doesn't fade.

That's what Miyazawa will have to prove to his counterparts in the

Group of Seven

this weekend. With Plan A foiled, he and his crew are reportedly locked up at the ministry working on Plan B.

It'll likely be a long night.