The G7 Daily Briefing seems to be becoming more interesting and more useful--at least, it teaches me things that I didn't know, and teaches them in a short space:

US Fiscal -- Not Much Stimulus This Year

The Bush tax package is clearly an ideological package aimed at getting Bush re-elected -- not stimulating the economy in '03. That may not make sense to the markets (which often make the mistake of thinking tax policy is driven by a desire to stimulate the economy). But it does make sense from a political perspective. The Bush political team learned from the mistakes of Bush Senior's failed bid for a second term. Hence, this package makes sure to deliver something to every element in the GOP base. Let's consider:

- Bush opted to deliver a tax break to small business (for political reasons -- there are 23 million small businesses in America). He declined to expand depreciation for large businesses. This matters because the top Fortune 500 companies are responsible for as much as 60% of capex in this country. That's why there's not much incentive for investment in this package.

- Big Business naturally gets its goodies via the dividend proposal, so it won't squawk about the fact that expanded depreciation was left out. The dividends portion should mean about $20 billion to wealthy taxpayers in '04 -- but everything else comes after that. (And that assumes that you get full repeal of the dividend tax credit, which we do not.) From the Bush perspective, it doesn't really matter if he gets the whole thing. It has delivered to the conservative supply-side of the base.

- Social conservatives get their goodies via acceleration of the tax credit for families with children and the acceleration of the marriage penalty relief. The most stimulative part of the package is the rebate checks for parents in families that earn below $110,000. Estimates are that that would add about .15% growth to GDP. We think that's about right -- if not high. Last time around, only 17% of rebates were spent as people used additional tax revenue to pay down debt.

- After toing and froing about whether to give money to the states, Bush opted not to give money to cash-strapped states, the worst off of which are headed by Democrats. This, naturally makes sense from a political perspective. Why bail out states struggling under Democratic governors (i. e. California, Virginia)? But states are struggling with deficits projected to reach a collective $75 to 85 billion -- up from $50 billion this year. So tax increases and spending cuts are certainly coming at a state level and there's no offset from the Feds.

Don't forget that no one will see one penny of this tax cut until it is enacted. The Bush team wants to drive it into law quickly, but that can only happen if they are prepared to cave early on the dividends provision.

If Democrats fight, then the debate will drag deep into next year. From an economic perspective that might not be so great, but from a political one, a protracted fight serves Bush well.

Bottom line: The Bush tax package is an ideological one aimed at getting Bush a second term -- not stimulating the economy. We think it will boost his re-election prospects more than it boosts the economy.

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Bank of Japan -- What Does the BoJ Mean by "Deflation Fighter?"

The political drumbeat is getting louder by the day for the Bank of Japan to fight deflation, with PM Koizumi calling for the next BoJ governor to be a "deflation fighter." So the BoJ is trying to fool politicians by playing a game of semantics: Governor Hayami has declared himself an unparalleled deflation fighter. At this point the BoJ is under siege. Politicians, including Koizumi, explicitly demand that the BoJ play a primary role in tackling deflation. Even MoF Vice Minister Muto elaborated on the view that price behavior is a monetary phenomenon, and therefore monetary policy would be an effective tool. The BoJ faces a dilemma: If it were to refuse flatly, the politicians might appoint a radical candidate as Hayami's replacement. So, instead of repeating its traditional argument that the government should fix the nation's banking system first, the BoJ now insists that the Bank has in fact been a deflation fighter. Moreover, they argue, Toshihiko Fukui -- a former BoJ deputy governor whose return is anxiously awaited by BoJ mandarins -- would fight deflation, so the PM does not need to appoint some outsider.

While markets often use the terms "deflation fighter" and "inflation targeting" interchangeably, the BoJ is quietly distinguishing between the two. In the eyes of the BoJ, "deflation fighter" is a vague description of someone's disposition, while "inflation targeting" refers to a monetary policy regime upon which the central bank's operation is based. While the BoJ advertises the former, the Bank has been careful not to commit (even the tiniest bit) to the latter. The Bank hopes that the semantics game will fool the politicians, including Koizumi. Seeing through all this, FSA Minister Takenaka, a trained economist, has specifically said that the BoJ should adopt inflation targeting. Takenaka sees inflation targeting not only as a way to fight deflation but also as a vehicle to tie the BoJ to further easing. MoF mandarins, too, understand the difference. However, they are divided. Someone like MoF international chief Kuroda favors it, but many MoF domestic guys -- i.e., budget hawks -- fear that inflation targeting may increase the ministry's debt-servicing costs by pushing up JGB yields.

When asked specifically about inflation targeting, the BoJ admits that it has no interest in adopting it. BoJ officials say that the Bank lacks the means to achieve the stated inflation goal, and many JGB traders in Japan share that view. The BoJ has long educated JGB traders to think about monetary policy within the traditional credit creation mechanics. Once one accepts this boundary, the amount of liquidity won't matter much as long as the banking system remains dysfunctional. An expansion of liquidity would only lead to an increase in bank reserves, without affecting broader money supply (i.e., M2+CD). The BoJ and JGB traders say that this is exactly what has happened despite quantitative easing. Therefore, they argue that additional JGB purchases here and there wouldn't achieve the targeted inflation level. It's a given that the next BoJ governor will buy more JGBs. (As the PM repeatedly has said that he wants a "deflation fighter," the next governor will have to appease Koizumi -- at least for a while.) Thus, in the BoJ's mind, the new governor can simultaneously be a deflation fighter and an inflation targeting skeptic.

We agree wholeheartedly that ending deflation won't be easy, but we disagree with the BoJ's defeatist argument that nothing can be done. The BoJ's argument is perfectly consistent as long as one accepts the view that monetary policy is limited to the money supply. What the BoJ doesn't tell you is that the borderline between monetary policy and fiscal policy inevitably becomes blurred at some point. If the central bank kept easing via purchase of government debt, it would end up financing the government's fiscal policy. When that line is crossed, monetary policy would start re-distributing wealth (as that is what fiscal policy is all about). The major difference between the two is that fiscal spending produces government debt, while the monetization of fiscal policy amounts to money creation. However, the BoJ is allergic to the notion of stepping into the gray area of monetization because it was once used as a money-printing machine to finance war efforts during WWII. (It is interesting to note that the US Fed -- having been criticized for its slow money-printing efforts during the Great Depression -- is now eager to cross the traditional boundary, should the US economy ever face a deflationary risk.)

Bottom line: With growing political pressure for the BoJ to be a "deflation fighter," the Bank now portrays itself as one. Don't be fooled by the semantics. Watch policy under the new Bank regime.