Appendix I: Summary of Policy Measures Taken in response to Exchange Rate Developments
The Japanese authorities have used measures other than foreign exchange market intervention as a tool of exchange rate policy. This appendix will present major episodes in which the Japanese authorities (1) changed the official discount rate, and (2) used capital control measures, in response to exchange rate movements. The discussion here, however, does not address the issue of whether these policy measures had their intended effects on the exchange rate.
Appendix II: Outline of the Monetary Control Mechanism 18/
As in any other central banking system, the Bank of Japan derives its ability to influence nominal interest rates from its ability to influence the supply of and demand for high-powered money (or base money). The Bank of Japan does not practice rigid high-powered money control, however, because it believes that the demand function for high-powered money is highly unstable in the short run. Instead, the Bank of Japan remains the residual supplier of base money in the short run and indirectly controls the long-run balance of base money by influencing the lending behavior of commercial banks through interest rates.
The Law Concerning the Reserve Deposit Requirement System of May 1957 mandates that the financial institutions under the system maintain a certain average balance of reserves (ABR) with the Bank of Japan during a given maintenance period (from the 16th day of each month through the 15th day of the next), determined by the legal reserve requirement ratio (r) times the average outstanding balance of deposits during the calendar month that ends at the midpoint of the reserve maintenance period, i.e., 19/
where t (=1, T) refers to the reserve maintenance period, i (=1, I) refers to the calendar month, RR is the daily reserve held at the central bank, and D is the amount of deposits.
The unique feature of the Japanese banking system is that the central bank implicitly guarantees that the relationship (6) holds for each bank on the 15th day of each month. As a result, Japanese banks hold virtually no excess reserves: the average amount of excess reserves in the banking system during a typical month is no more than 0.1 percent of total reserves held at the central bank. However, each bank has some discretion as to how to allocate the average balance of required reserves over the maintenance period. This constitutes the key mechanism by which the central bank influences nominal interest rates on a daily basis.
This mechanism consists of two tools. The first is the accounting concept called the “reserve progress ratio (RPR)” defined as:
where j (=1, t) is the portion (up to the t-th day) of the reserve maintenance period. The reserve progress ratio at time t shows the proportion of actual reserves accumulated up to that time in the aggregate balance of total required reserves for the reserve maintenance period (for which the projected value is used before the end of the calendar month). On the last day of the reserve maintenance period (j=T), the Bank of Japan guarantees that RPRT = 1 for each bank, by extending or recalling loans.
The second tool is the use of the discount window. In Japan, the central bank maintains the official discount rate below interbank interest rates, allowing it to ration credit at its discretion. In calculating the effective rate of discount, the Bank of Japan counts the day on which the credit is extended as one full day under the “method of counting both ends”. If, for example, a bank receives credit from the discount window at 4 percent for one day, the effective rate becomes 8 percent. In this manner, the Bank creates incentives for commercial banks to smooth out their discount window borrowing over a longer period by discouraging extremely short-term borrowing.
In controlling interest rates, the Bank of Japan defines the “path of reserve accumulation” in which the required reserves are maintained equally every day as the standard path (i.e., RPR increases by 1/T a day during the maintenance period). If the Bank desires to tighten monetary conditions, it will reduce the RPR of the banking system relative to the standard path by reducing direct lending or selling securities. The increased RPR will in turn raise interbank interest rates through two channels. First, given the penal rate system for short-term discount borrowing, it will induce some banks to begin to borrow in the call market. Second, it will provide a signal of the tighter stance of monetary policy, causing expectations of higher interest rates.
It is believed that an increase in the interbank rates limits the expansion of the money supply through three channels (Suzuki 1986). First, it tends to reduce the expansion of bank loans by lowering the profitability of bank lending. Second, it reduces corporate investment demand by increasing market interest rates through arbitrage (Takagi 1987, 1988c). Third, with some deposit rates still fixed, it will result in disintermediation. If this type of monetary control mechanism is strictly in operation, then, the direction of causality should run, not from the monetary base to M2 plus CDs, but from interbank interest rates to M2 plus CDs and then, through the residual supply of high-powered money, to the monetary base. In practice, however, the monetary base does seem to cause (in the sense of Granger) the money supply at least in quarterly average data, as reported in the text.
Appendix III: Sources of Data
Fukao, Mitsuhiro, “Ninon no Kawase Kanri no Jiyuka to Kokusai Shushi Kozo no Henka (Liberalization of Exchange Controls and Changes in the Structure of International Payments in Japan)”, Working Paper 1-6, Institute for Monetary and Economic Studies, Bank of Japan, July 1989.
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)| false “ Fukao, Mitsuhiro, Ninon no Kawase Kanri no Jiyuka to Kokusai Shushi Kozo no Henka (Liberalization of Exchange Controls and Changes in the Structure of International Payments in Japan)”, Working Paper 1-6, Institute for Monetary and Economic Studies, Bank of Japan, July 1989.
Fukao, Mitsuhiro, and Kunio Okina, “Internationalization of Financial Markets and Balance of Payments Imbalances: A Japanese Perspective”, Carnegie Rochester Conference Series on Public Policy 30, Spring 1989, 167–220.
Funabashi, Yoichi, Managing the Dollar: From the Plaza to the Louvre. Washington, D.C., Institute for International Economics, 1988.
Hamada, Koichi, “Policy Interactions and the United States-Japan Exchange Rates”, in Kozo Yamamura (ed.), Policy and Trade Issues of the Japanese Economy: American and Japanese Perspectives, Seattle and London, University of Washington Press, 1982, 271–295.
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)| false “ Hamada, Koichi, Policy Interactions and the United States-Japan Exchange Rates”, in ( Kozo Yamamura ed.), Policy and Trade Issues of the Japanese Economy: American and Japanese Perspectives, Seattle and London, University of Washington Press, 1982, 271– 295.
Hutchison, Michael M., “Official Japanese Intervention in Foreign Exchange Markets: Leaning Against the Wind?”, Economics Letters 15, 1984, 115–120.
Hutchison, Michael M., “Monetary Control with an Exchange Rate Objective: The Bank of Japan, 1973-86”, Journal of International Money and Finance 7, September 1988, 261–271.
Ito, Takatoshi, “The Intradaily Exchange Rate Dynamics and Monetary Policies after the Group of Five Agreement”, Journal of the Japanese and International Economies 1, September 1987, 275–298.
Ito, Takatoshi, “Was There a Target Zone?”, in Monetary Reforms: Introducing the Target Zone. Tokyo, Japan Center for International Finance, June 1989, 27–40.
Kindleberger, Charles P., “The Case for Fixed Exchange Rates, 1969”, in The International Adjustment Mechanism. Boston, Federal Reserve Bank of Boston, 1969, 93–108.
Komiya, Ryutaro and Miyako Suda, Gendai Kokusai Kinyuron (Contemporary International Finance), Tokyo, Nihon Keizai Shinbunsha, 1983.
Meltzer, Allan H., “Monetary and Exchange Rate Regimes: A Comparison of Japan and the United States”, Cato Journal 6, Fall 1986, 667–683.
Obstfeld, Maurice, “The Effectiveness of Foreign-Exchange Intervention: Recent Experience,” NBER Working Paper No. 2796, December 1988.
Ohta, Takeshi, “Exchange-Rate Management and the Conduct of Monetary Policy”, in P. Meek (ed.), Central Bank Views on Monetary Targeting. New York, Federal Reserve Bank of New York, 1982, 126–131.
Otani, Ichiro and Siddharth Tiwari, “Capital Controls and Interest Rate Parity: The Japanese Experience, 1978-81”, Staff Papers 28, December 1981, International Monetary Fund, 793–815.
Quirk, Peter J., “Exchange Rate Policy in Japan: Leaning Against the Wind”, Staff Papers 24, November 1977, International Monetary Fund, 642–664.
Suzuki, Yoshio, “Japan’s Monetary Policy Over the Past 10 Years”, Bank of Japan Monetary and Economic Studies 3, September 1985, 1–9.
Suzuki, Yoshio, Akio Kuroda and Hiromichi Shirakawa, “Monetary Control Mechanism in Japan”, Bank of Japan Monetary and Economic Studies 6, November 1988, 1–27.
Takagi, Shinji, “Transactions Costs and the Term Structure of Interest Rates in the OTC Bond Market in Japan”, Journal of Money. Credit, and Banking 19, November 1987, 515–527.
Takagi, Shinji, Recent Developments in Japan’s Bond and Money Markets”, Journal of the Japanese and International Economies 2, March 1988a, 63–91.
Takagi, Shinji, “On the Statistical Properties of Floating Exchange Rates: A Reassessment of Recent Experience and Literature”, Bank of Japan Monetary and Economic Studies 6, May 1988b, 65–95.
Takagi, Shinji, “Financial Liberalization and the ‘Bills-Only” Doctrine: A Causality Test of Daily Japanese Data, 1978-85”, Economic Studies Quarterly 39, June 1988c, 149–159.
The author gratefully acknowledges valuable information received from Mitsuhiro Fukao, Akio Kuroda and Hirochika Nishikawa of the Bank of Japan, useful comments of James Boughton, Nurun Choudhry, Michael P. Dooley, Yuzo Harada, Bennett T. McCallum, Steven Symansky and other Fund colleagues, and valuable research assistance of Toh Kuan. The author alone is responsible for any remaining errors.
The rate of both wholesale and consumer price inflation remained well below 5 percent per year after the series of oil price hikes in 1980.
See Appendix I for a brief outline of other policy measures taken in response to exchange rate movements during 1973-89.
Those familiar with the U.S. Federal Reserve System can think of the. role of foreign exchange bills as analogous to that of gold certificates in the U.S. system.
The volume of intervention during the 7-month period from March to September 1973 was estimated to be about 50 percent of the total volume of foreign exchange trading in Tokyo (Komiya and Suda, 1983).
The volume of intervention in November 1977 and in March 1978 was estimated to be about 32 percent and 44 percent, respectively, of the volume of foreign exchange trading in Tokyo (Komiya and Suda, 1983).
Past attempts to estimate the intervention equation jointly with an exchange rate determination equation by (say) two-stage least squares have not been successful (see, for example, Quirk, 1977). The well-known empirical observation that short-run exchange rate behavior is closely approximated by a random walk process makes it difficult to structurally model exchange rate determination or to justify the use of lagged changes in the exchange rate as an instrumental variable (Takagi, 1988b).
This follows from the fact that the balance sheet of the monetary authorities in the monetary survey is the consolidated account of the Bank of Japan and the Foreign Exchange Fund Special Account of the central government.
The major components included in the analysis are bills discounted, loans, bills purchased and government bonds (see Appendix III for the source of data). The other components are not explicitly included, because they are generally minor and stable. The seasonal variation (corresponding to tax receipts) of government deposits—also minor in absolute magnitude—is captured in the seasonal dummies.
The figure would be about 30 percent if we used the unadjusted value of official foreign assets (i.e., FA in the text).
This high interest rate policy was eased in late August and completely terminated in late November, in response mainly to domestic considerations (Komiya and Suda, 1983).
Financial institutions are subject not only to the Foreign Exchange Law but also to the prudential regulation of the Ministry of Finance.
The Japanese authorities emphasize that these temporary restrictions represented only the “voluntary compliance” of the financial institutions.
For a more detailed exposition, see Suzuki, Kuroda, and Shirakawa 1988.
Here, I am abstracting from the fact that there are different types of deposits that are subject to different reserve requirements.