By Leika Kihara
WASHINGTON (Reuters) - Bank of Japan Governor Haruhiko Kuroda said on Sunday a mix of monetary easing, flexible fiscal spending and structural reforms to raise the country's long-term growth potential could be effective in stimulating the economy.
Kuroda said central banks of advanced nations still have sufficient tools to boost growth, countering the view that years of low-growth, low-inflation environment have left them with little ammunition to fight an economic downturn.
But he said fiscal spending and structural reforms to boost an economy's potential growth will help enhance the effect of monetary easing.
"We are equipped with unconventional tool kits, so there is no need to be too pessimistic about the effectiveness of monetary policy," Kuroda told a seminar on long-term policy challenges for central banks.
"In responding to significant downward pressure (on growth), a policy mix of monetary easing, flexible fiscal policy and steps to raise the natural rate of interest could be effective."
The remarks came after the widening fallout from the bitter U.S.-China trade war forced the International Monetary Fund to cut its world growth forecast, putting pressure on central banks to do more to fend off heightening global risks.
The BOJ has signaled the chance of easing as early as this month as weak global demand hurt Japan's export-reliant economy.
Kuroda said while the BOJ will maintain its massive stimulus program to achieve its 2% inflation target, it must also take steps to reduce the cost of prolonged easing.
"Financial system stability should be addressed primarily through macro-prudential steps. But no prudential tool-kit is perfect," Kuroda said.
"Monetary policy influences broad areas of financial activity. The BOJ should examine financial functioning and make appropriate policy responses, so that the cost of monetary easing is reduced."
Kuroda also said the BOJ saw the need to "pay attention to the shape of the yield curve," as excessive falls in super-long bond yields will flatten the curve and erode the returns pension funds and insurance firms earn from their investment.
Japan has not faced a situation yet where ultra-low rates hurt financial institutions' profits enough to discourage them from lending, he said.
But such negative effects of prolonged easing are cumulative and so must be carefully monitored, he added.
"It's not a serious problem now. But in five or 10 years' time, it could be a serious problem," he said, adding the BOJ will likely accompany any additional monetary easing steps with measures to mitigate the side effects.
Subdued inflation has forced the BOJ to maintain ultra-low rates for years, hurting financial institutions' profits and leaving it with fewer tools to fight the next recession.
Under a policy called yield curve control (YCC), the BOJ pledges to guide short-term rates at -0.1% and the 10-year government bond yield around 0%.