Architect of BOJ stimulus calls for big fiscal spending backed by c.bank
* Japan must ramp up fiscal spending with BOJ help - ex-BOJ depgov
* Current BOJ policy alone won't hit 2 pct inflation - Iwata
* Adds further BOJ rate cuts could bring some banks under
* Japan must ditch sales tax hike, take steps to boost consumption
By Leika Kihara
TOKYO, Feb 18 (Reuters) - Japan must ramp up fiscal spending with debt bank-rolled by the central bank, the Bank of Japan's former deputy governor Kikuo Iwata said, a controversial proposal that highlights the BOJ's challenge as it tries to reignite an economy after years of sub-par growth.
Iwata, an architect of the BOJ's massive bond-buying programme dubbed "quantitative and qualitative easing" (QQE), warned that inflation will miss the central bank's 2 percent target without stronger measures to boost consumption.
He said there are few tools left to ease monetary policy further as cutting already ultra-low interest rates could push some financial institutions into bankruptcy.
That means Japan must lean on fiscal policy by ditching this year's scheduled sales tax hike and committing to boost government spending permanently with money printed by the BOJ, he said.
"Inflation won't hit 2 percent just with the BOJ continuing its current policy. The BOJ doesn't need to change its policy much now. What needs to change is fiscal policy," Iwata said.
"Fiscal and monetary policies need to work as one, so that more money is spent on fiscal measures and the total money going out to the economy increases as a result," he told Reuters on Friday. "That's the only remaining policy option."
Instead of relying on commercial banks to lend more to already cash-rich companies, the BOJ should finance government spending for measures to boost consumption such as payouts or tax breaks for younger-generation households, he said.
"The BOJ's current policy does not have a mechanism to heighten inflation expectations. We need a mechanism where money flows out to the economy directly and permanently," Iwata said.
The remarks by Iwata, who six years ago had said the BOJ is solely responsible for achieving 2 percent inflation, underscore the challenge the bank faces in hitting its elusive price goal.
Iwata, a former academic who retired last year, retains strong influence among some reflationist-minded executives of the BOJ's nine-member board like Yutaka Harada, Goushi Kataoka and deputy governor Masazumi Wakatabe.
His proposal resembles the idea of "helicopter money" - a policy where the central bank directly finances government spending by underwriting bonds.
The BOJ currently buys bonds aggressively to cap long-term rates around zero.
However, BOJ Governor Haruhiko Kuroda and many government officials say the central bank is not resorting to helicopter money, since it buys bonds from financial institutions, and not directly from the government. Existing regulation prohibits the BOJ from directly underwriting government debt.
Iwata said the BOJ can continue to buy government bonds via financial institutions, but must be ready to ramp up purchases if the government decides to issue more debt to finance big fiscal spending.
"The term debt monetisation has been taboo in Japan. But in a way, Japan is already resorting to debt monetisation," Iwata said.
"We're still on the cusp of emerging from deflation and that process is still fragile," he said. "Inflation needs to pick up via an expansion in demand." (Reporting by Leika Kihara, additional reporting by Sumio Ito Editing by Shri Navaratnam)
