Saturday, June 30, 2007

The Bank of Japan's Inflation Threat Scale

Given events in the UK this weekend, we not only have to contend with Red Alerts from the Dept of Homeland Security, but market practitioners must contend with a new system introduced today in Japan. Taking a cue from the United Kingdom's Home Office, the Bank of Japan has initiated an "Inflation Threat Scale" in an attempt to forewarn the nation, and especially foreign policy-makers and market participants of threats that might require changes in official BoJ interest rate policy.

Threat levels are designed to give a broad indication of the likelihood of an inlation attack. They are based on the assessment of a range of factors including what PBoC and other exporting competitors are doing, where the YEN is trading at, recent events and what is known about our export markets, trading partner intentions and competitor capabilities. This information may well be incomplete and decisions about the appropriate interest rate policy response are made with this in mind. Together with the detailed assessments behind them, this analysis informs practitioners in key sectors and the Ministry of Finance of the potential threat of an inflation attack. Threat assessments are also produced as necessary for corporations, individuals and specific events. There are five threat levels which inform decisions about the levels of Interest Rates needed to protect our Critical Mercantile Advanatge (CMA).

* LOW : an attack is possible, but rather unlikely
* MODERATELY LOW: an attack is possible, but not likely, at all.
* SUBSTANTIALLY LOW: an attack is strongly impossible
* SEVERELY LOW: an attack is highly impossible
* CRITICALLY LOW: an attack is incredibly impossible, not to mention rather unlikely

In reaching a judgement on the appropriate threat level in any given circumstance several factors need to be taken into account, these include:

Available Intelligence: It is rare that specific threat information is available and can be relied upon. More often, judgements about the threat will be based on a wide range of information, which is often fragmentary, including the level and nature of current economic activity, comparison with events in other countries and previous inflation attacks. Intelligence is only ever likely to reveal part of the picture, and therefore is typically used only as an excuse to keep threat levels unchanged.

Inflationary Capability: An examination of what is known about the capabilities of the inflation in question and the method they it may arise based on previous attacks or from available intelligence. This would also analyse the potential scale of the potential inflationary attack.

Inflationary Type: Using intelligence and publicly available price informaton to examine the type of the inflation and the ways it may arise including what sort of targets it would consider attacking (wages, consumer goods prices, services, assets etc.).

Inflationary Timescale: The threat level expresses the likelihood of an outbreak or attack in the near term. We know from past incidents that some attacks take years to plan, while others arise more quickly. In the absence of specific intelligence, a judgement will need to be made about how close an attack might be to fruition. Threat levels do not have any set expiry date, but are regularly subject to review in order to ensure that they remain current.

WHO DECIDES THREAT LEVELS? The Joint Action Committee (JAC), a panel derived from Finance Ministry adn Central Bank policymakers, in combination with the Office of Financial Fairness (OFF) was created for the analysis and assessment of international inflation. JAC is responsible for setting inflation threat levels and Ministers are informed of its decision. It also issues warnings of inflation threats and other infaltion -related subjects for customers from a wide range of government departments and agencies, as well as producing more in-depth reports on trends, inflationary networks and capabilities. The Ministry Internal Security Service (MISS) is responsible for assessing the level and nature of the threat arising from domestic inflation, principally the Leveraged FX Day-Trader and related carry-trade oriented threat.

WHERE CAN ONE FIND OUT WHAT THE CURRENT NATIONAL THREAT LEVEL IS? National threat levels are continually monitored and are altered as required for our own protection for the purpose of demonstrating to foreign authorities that Japan is doing something. We cannot anticipate how frequently they may be amended as this is dependent on available intelligence at any one time. From the 1st August, information about the national threat level will be available on the BoJ's Website and Ministry of Finance's Website.

WHAT ARE "RESPONSE LEVELS" AND HOW DO THEY RELATE TO THREAT LEVELS? Response levels provide a broad indication of the protective measures that should be applied at any particular moment. They are set by financial policy practitioners in Government and in some Critical National Mercatile sectors. They are informed by the threat level but also take into account specific assessments of vulnerability and risk. Response levels tend to relate to market moves in a direction against desired market moves, whereas threat levels usually relate to broad areas of activity. Within response levels, there is a variety of measures that can be applied as appropriate – the response level will not produce the same measures at every location. Many of the measures will not be obvious or visible to the public, but will be evident to market participants and practitioners, or members of the press that report counter anti-inflationary policy-spin .

There are three levels of response which broadly equate to threat levels as shown below:

* NORMAL - Routine protective policy. Low and Moderate measures appropriate to the business concerned. This typically is represented by ZIRP and near ZIRP.

* HEIGHTENED - Additional and sustainable policy measures, for example the increase in fiscal deficits, or MoF claim that tax receipts may fall short.

* SUBSTANTIAL - Sever and protective policy measures reflecting the broad nature of the threat combined with specific business and geographical vulnerabilities and judgements on acceptable risk. This may include changing of domestic regulations to encourage greater flow of funds abroad, and other measures like insulting the PBoC officers in order to deter Chinese accumulation of YEN reserves.

* EXCEPTIONAL - Maximum policy measures including broad and concerted media compaign to counter a potentially Strong YEN, and all of the other polciy measures mentioned above.

* CRITICAL - Critical measures to meet specific threats and to minimise vulnerability and risk. For example in response to the YEN strength in mid 1990s. Dr Sakakibara engineered a massive intervention that changed the course of currency market history. Similarly weakness in 2004 was met with huge intervention and reserve accumulation. Any and all policy measures and actions are on the table when this threat level is reached. The policy measures taken to protect people and Critical Mercantile Advantage will not be announced publicly, to avoid informing foreign political authorities about our true intentions. Because response levels are the result of detailed assessments of risk to specific elements of the Critical Mercantile Advantage, changes in the national threat level will not necessarily produce changes to the sector-specific response levels.

No comments: