TOKYO Japan's next government should set a price target for the Bank of Japan and the central bank should increase purchases of government debt to end deflation, said Heizo Takenaka, an economist with close ties to the Liberal Democratic Party.
A goal ranging from a 1 to 3 percent increase in consumer prices is appropriate and the BOJ should use government bond purchases instead of trying to boost lending in the private sector, Takenaka told Reuters in an interview.
Purchasing foreign bonds is an option, but the first step for the BOJ should be to focus on the more "orthodox" tool of government debt purchases and to step back from purchases of riskier assets, said Takenaka, a former economics minister under LDP rule.
"The BOJ has been throwing a lot of curve balls by trying to provide funding to companies," he said.
"It's the rate of change in the BOJ's balance sheet, not the size, that will influence price expectations. Once the BOJ influences expectations, those expectations become a self-fulfilling prophecy."
Takenaka says he is close to the LDP's head Shinzo Abe but is not interested in a position on the BOJ's board or in the next cabinet.
Media opinion polls suggest that the LDP will win the biggest number of seats in parliament's powerful lower house in an election on December 6.
That would give Abe, a former prime minister who quit suddenly in 2007 after a series of scandals, another chance to form a government.
Abe has put monetary policy firmly on the agenda with his repeated calls to revise the law to introduce a 2 percent inflation target and curtail the BOJ's independence to help beat persistent deflation.
Revision of the laws regulating the BOJ may not be necessary, but the BOJ does need a binding price target to ensure that the biases of different broad members do not prevent the central bank from easing policy, Takenaka said.
Takenaka criticized Abe's pledge to increase public works spending as "provocative" given Japan's public debt burden is the worst among major economies.
Selling public assets to fund new public works could be positive for growth, but the LDP should avoid falling back on excessive public works spending, the hallmark of its economic policies during its more than half a century of nearly non-stop rule of the country.
"It is clear we cannot increase public debt from now, Takenaka said. "If some old-fashioned LDP members are considering some old-fashioned public works from the 90s, then it would not work."
Takenaka served as economics and privatization minister under former LDP Prime Minister Junichiro Koizumi about 10 years ago and is widely considered to be the brain behind economic policy at the time.
Koizumi made a big push for structural reforms that met with mixed results, but successive governments have largely shied away from painful reforms that many economists say are needed to recharge Japan's economy.
Japan needs to re-direct welfare spending so families, women and younger people benefit more than the elderly, said Takenaka, who is currently a professor at Keio University in Tokyo.
The government also needs to end a debt restructuring scheme for small firms as this discourages bank lending, he said.
The Bank of Japan will take decisive action to support the economy if risks to the outlook heightens, one of its deputy governors said on Wednesday, offering the strongest signal to date from a policymaker of the bank's readiness to ease policy again this month.
Deputy Governor Kiyohiko Nishimura also strengthened the central bank's commitment to ultra-easy policy, saying that it will keep its asset-buying programme in place even after the end-2013 deadline for purchases if 1 percent inflation is not foreseen by then.
The BOJ set the 1 percent inflation target in February and eased four times this year in an effort to revive the economy and show its determination to beat deflation.
But the economy shrank 0.9 percent in the September quarter and is expected to contract again this quarter, meeting the popular definition of a recession, as the country deals with the global headwinds of debt-ridden Europe and a sluggish U.S. economy.
(Editing by Kim Coghill)