This paper provides a brief overview of the causes of the poor economic performance of Japan in the 1990s, and a more detailed analysis of developments in the real sector during 1999. The paper highlights that the collapse of the asset price bubble in 1990–91 provided the trigger for the downturn in 1992, and compounded the economic problems thereafter through its effects on the banking system. This paper also analyzes the fiscal policy developments and the monetary developments in Japan.

Abstract

This paper provides a brief overview of the causes of the poor economic performance of Japan in the 1990s, and a more detailed analysis of developments in the real sector during 1999. The paper highlights that the collapse of the asset price bubble in 1990–91 provided the trigger for the downturn in 1992, and compounded the economic problems thereafter through its effects on the banking system. This paper also analyzes the fiscal policy developments and the monetary developments in Japan.

III. Monetary Developments1

1. Monetary policy has become even more expansionary over the past year, against a backdrop of weak activity, deflationary pressures, and continuing banking system strains. This chapter first discusses monetary policy developments over the past year, including the conduct of monetary policy at zero interest rates, then describes actions taken to support bank lending, and finally considers what options remain should it become necessary to ease policy further.

A. Monetary Policy Developments

2. Financial markets experienced considerable volatility throughout much of the past year. Starting in late June 1998, the widely-reported difficulties of the Long-Term Credit Bank raised market concerns about banking system weaknesses, as reflected in rising bank funding premia (Figure III.1). Turbulent global financial market conditions in August and September further increased risk premia and the demand for liquidity. To ease monetary conditions and stabilize financial markets, the Bank of Japan (BOJ) cut the overnight call rate—its operating target—from slightly below 0.50 percent to 0.25 percent on September 9, 1998.

FIGURE III.1
FIGURE III.1

JAPAN: BANK FUNDING PREMIA

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Sources: Nikkei Telecom, WEFA, Bloomgerg, and staff estimates.1/ Average U.S. dollar LIBOR of Sumitomo Bank, Fuji Bank, and Bank of Tokyo minus the LIBOR fix.2/ Gensaki is a repurchase agreement for government paper.

3. Growing concerns about the financing of the government budget deficit led to a sharp increase in government bond yields in late 1998 and early 1999 (Figure III.2). The rise in yields was accelerated by major banks’ desire to limit losses on their bond portfolios in the run-up to the March 1999 public capital injections. The rush to liquidate positions spread to other markets, including the currency market, which put upward pressure on the yen. The resulting appreciation of the yen tightened monetary conditions, as measured by the nominal monetary conditions index (Figure III.3).2

FIGURE III.2
FIGURE III.2

JAPAN: SELECTED INTEREST RATES, 1997–99

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Source: Bank of Japan, Economic Statistics Monthly; and staff calculations.
FIGURE III.3.
FIGURE III.3.

JAPAN: NOMINAL MONETARY CONDITIONS INDEX, 1997–99

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Source: Staff calculations.

4. In response, the BOJ cut the overnight call rate to “as low as possible” on February 12,1999. In view of concerns about the impact on the functioning of money markets, the BOJ followed a two-stage approach: first, the rate would be guided from about 0.25 percent to about 0.15 percent; then, depending on market developments, the rate would be guided lower. Following the policy change on February 12, the rate fell quickly to about 0.15 percent, then stayed around 0.10–0.15 percent until the end of February, fell again to about 0.03–0.05 percent in March, and has remained at 0.03 percent since early April. After accounting for brokerage commissions, this implies an overnight call rate of zero. Finally, in mid-April, the Governor announced that the BOJ would “maintain the current zero interest rate policy until deflationary concerns are dispelled”.

5. The BOJ combined the cut in the overnight call rate with the aggressive provision of liquidity to the financial system. The policy directive for the February 1999 interest rate cut emphasized that—in order to maintain the stability of money markets—the BOJ would inject ample liquidity, even beyond the level required to hold the overnight call rate at its target. This, combined with the April commitment to keep policy loose while deflationary concerns remain, lowered the entire term structure of interest rate and helped to ease liquidity strains, as reflected in declining risk premia. Against the background of the government’s recapitalization of major banks, the monetary easing in February 1999 led to the virtual disappearance of the Japan premium and the narrowing of other bank funding premia, signaling an end to the immediate financial crisis.

6. The recent easing of financial strains has allowed the size of the BOJ’s balance sheet to shrink (Table III.1). During the period of financial turbulence, the BOJ provided funds to some financial institutions and absorbed funds from others, which increased the BOJ’s intermediation in the interbank market and the size of its balance sheet. Over the past year, the BOJ injected liquidity primarily through its conventional instruments, including repurchase operations in government bonds and commercial paper (CP), and outright purchases of government bonds were kept in line with the growth of currency outstanding. The BOJ also made loans to the Deposit Insurance Corporation (DIC) mainly to assist with the government’s nationalization of two major banks. While liquidity injections before February 1999 were mostly sterilized through sales of BOJ bills, since then excess reserves have risen to unprecedented levels.

Table III.1.

Japan: BOJ Balance Sheet

(In trillions of yen, end period)

article image

7. Excess deposits at the BOJ rose sharply, not only for banks, but also for financial institutions not subject to reserve requirements, such as money market brokers and securities dealers (Figure III.4). The bulk of banks’ excess reserves have in fact been held by only a few institutions, primarily nationalized banks and foreign banks, reflecting concerns about the shrinking money market. However, most banks have not wanted to hold excess reserves and have deposited excess funds with money market brokers, which in turn hold them at the BOJ. Money market brokers have agreed to take on these excess deposits largely in order to maintain long-term relationships with banks. Excess funds held by money market brokers are unlikely to have a significant macroeconomic impact, as these institutions cannot expand loans and create deposits in the same manner as banks, though it is possible that the funds could be channeled into asset markets.

Figure III.4.
Figure III.4.

Japan: Excess Deposits at BOJ, 1997–99 1/

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Source: Bank of Japan.1/ Cumulative amount for reserve maintenance period (16th of month to 15th of following month).2/ Financial institutions not subject to reserve requirement.3/ Financial institutions subject to reserve requirement.

8. The decline in interest rates to effectively zero has led to a shrinking of the call money market. The outstanding amount in the call money market fell from about ¥35 trillion in February to about ¥20 trillion in June. Several suppliers of funds—such as life insurance companies—have shifted into bank deposits, which in turn has led banks to cut deposit rates from 0.10 percent to 0.05 percent. The BOJ remains concerned that a further decline in volume could make it more difficult for financial institutions to adjust their liquidity, potentially leading to higher volatility of the call rate when banks misjudge their liquidity needs. So far, however, financial institutions have not had any difficulties in lending funds to or borrowing funds from the call market.

9. With the overnight call rate at its floor, market participants know that the next move is up, which has focussed attention on how long the current “zero rate” policy will be maintained.3 Specifically, in March and April 1999, some market participants became concerned that monetary policy might be tightened following the passing of liquidity pressures associated with the fiscal year end. The BOJ Monetary Policy Board therefore decided at its meeting on April 9 to make an explicit commitment to “maintain the current zero interest rate policy until deflationary concerns are dispelled,” which was communicated to markets through the Governor’s subsequent press conference and the publication of the minutes of the meeting. These actions were successful in convincing markets of the BOJ’s commitment to its current policy stance, as reflected in the continued flattening of the yield curve through May (Figure III.5). However, more encouraging recent news on the economy—including the first quarter 1999 GDP figures and June Tankan survey—have led to a rise in the yield curve as market participants have begun to suspect that deflationary pressures may dissipate more rapidly than previously anticipated.

Figure III.5.
Figure III.5.

Japan: Yield Curves 1/

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Sources: Nikkei Telecom; and WEFA.1/ The graph shows the overnight call rate, 3-, 6-, and 12-month Euro yen rates, and government bond yields from 3 to 10 years.

10. Notwithstanding the generally expansionary stance of monetary policy, the growth of the monetary base fluctuated considerably over the past year (Figure III.6). During the financial market turbulence in the second half of 1998, the monetary base grew around 8–10 percent year-on-year, as it had done since the onset of the financial crisis in late 1997. However, in December 1998 and January 1999, the demand for currency—the main component of the monetary base—fell sharply, owing to increased confidence in the banking system and lower end-year bonus payments. Following the further easing of policy in February 1999, the growth rate of the monetary base has returned to its pre-crisis level of about 7 percent year-on-year. By contrast, broad money growth has been relatively stable at 4–5 percent year-on-year.4

FIGURE III.6.
FIGURE III.6.

JAPAN: MONEY AND CREDIT GROWTH, 1997–99

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Sources: Bank of Japan, Economic Statistics Monthly; and staff calculations.

B. Measures to Support Bank Lending

11. Notwithstanding the stabilization of the banking system, bank lending has continued to decline (Figure III.6). While the headline figure (-5.7 percent during the year ended June 1999) exaggerates the degree of contraction, because it is not adjusted for loan securitization, loan write-offs, and other special items, the adjusted data also show a decline (-1.2 percent) during the past year.5 The contraction in bank lending reflects several factors, including lower desired investment spending by firms, lenders’ increased sensitivity to risk, and banks’ desire to reduce risk assets to improve their capital adequacy ratios.

12. In normal times, monetary easing by itself would stimulate aggregate demand, in part through the bank lending channel. Monetary easing usually boosts bank lending by improving banks’ liquidity and—in Japan—by increasing the value of banks’ holdings of stocks, which improves banks’ solvency. However, given banking sector weaknesses, this monetary transmission mechanism has been less effective than usual.6 Therefore, to help sound companies obtain loans, the government and the BOJ took four sets of measures over the past year: increased loan guarantees; expanded lending by government financial institutions (GFIs); use of public funds to recapitalize private banks; and the introduction of new BOJ facilities to improve the liquidity of corporate debt.

13. First, the government sharply expanded the loan guarantee program for small and medium-sized enterprises (SMEs), which account for three-quarters of nonagricultural employment. Loan guarantees are given by local government credit guarantee associations, which in turn reinsure 70–80 percent of the amount with the central government’s Small Business Credit Insurance Corporation (SBCIC). The credit guarantee associations, of which there are 52 nationwide, have altogether about ¥1 trillion in capital, and participating firms pay guarantee fees of 0.5–1.0 percent of the loan. Effective October 1998, the overall ceiling for such guarantees was raised by ¥20 trillion (4 percent of GDP), to be used by March 2000, and the loan amount obtainable without collateral was doubled to ¥100 million.

14. By reducing credit risk premia for SMEs, the loan guarantees were effective in unlocking bank lending. Outstanding loan guarantees increased from ¥30 trillion as of September 1998 to ¥42 trillion in March 1999 (Figure III.7). Loan guarantees in March amounted to 13 percent of private bank lending to small businesses and 9 percent of total private bank lending. The success of the loan guarantee program can be seen in the more rapid growth of lending by regional banks, especially second-tier regional banks, which lend primarily to SMEs, compared to the growth of lending by city banks, which lend primarily to large firms (Figure III.6). The decline in the number of bankruptcies of small firms since the beginning of 1999 and the increase in investment by small firms (reflected in the strong business investment figure for the first quarter of 1999) are also attributable to the loan guarantee program.

FIGURE III.7.
FIGURE III.7.

JAPAN: CREDIT GUARANTEES AND BANKRUPTCIES, 1997–99

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Sources: Nikkei Telecom; and Bank of Japan, Economic Statistics Monthly.

15. However, this macroeconomic support comes at the cost of higher contingent liabilities for the public sector and microeconomic distortions. The key aspect of the loan guarantees is that the government takes on the credit risk inherent in lending to SMEs, which undermines banks’ incentives to make adequate assessments of credit quality and firms’ incentives to make good use of borrowed funds, and increases the government’s role in the allocation of credit.7 The government has pledged ¥1 trillion of additional funds as needed to help cover possible loan losses associated with the ¥20 trillion increase in loan guarantees.

16. Second, the government increased lending by GFIs in late 1998 and early 1999. To spur GFI lending, which amounts to almost one-third of lending by private banks and has been an increasingly important source of funds for the corporate sector, lending criteria were relaxed. The definition of “small firms” was broadened from SMEs (with capital less than ¥100 billion) to include larger firms (with capital up to ¥500 billion). In addition, the Japan Development Bank was allowed to lend not only for long-term capital investment, but also for working capital and to meet maturing bond obligations. To support this increased lending by GFIs, the April and November 1998 fiscal stimulus packages increased the Fiscal Investment and Loan Program’s allocation of funds to GFIs in FY1998 by more than ¥3 trillion (15 percent) compared to the initial budget. As a result, the growth rate of lending by GFIs has increased in recent months (see lower panel of Figure III.7).

17. Third, the recapitalization of most major private banks with public funds in March 1999 relieved pressures to improve capital adequacy ratios by reducing risk assets. As a condition for receiving public money, major banks promised to expand lending by ¥6.7 trillion (2½ percent) in FY1999, with nearly half earmarked for small and medium-sized enterprises.8

18. Fourth, the BOJ expanded existing CP operations and introduced new facilities to improve liquidity of corporate debt in late 1998 and early 1999. The BOJ took three measures to support the extension of bank credit to corporations, especially towards the end of the calendar year and the fiscal year:

  • The maturity ceiling for CP that could be used in the central bank’s repurchase operations was increased from 3 months to one year, effective November 16.

  • A new lending facility was established on November 27 that allowed banks to refinance up to 50 percent of the increase in their loan balance since September 1998. The refinance credits carried an interest rate of 0.5 percent and matured in April 1999, after the end of the fiscal year. At least half of the collateral had to be in the form of private firms’ debt obligations.

  • A new market operation was started in April 1999 under which the central bank purchases bank bills that are collateralized solely by corporate bonds and loans on deeds. This differs from the existing discount window in that purchases are generally made on a two week schedule and prices are market-determined through an auction.

19. The BOJ measures helped banks obtain liquidity, as they were broadly equivalent to an expansion of discount window lending, and thus supported corporate funding. In effect, the BOJ offered to turn illiquid assets into liquid ones, which was helpful in relieving banking system strains. However, with the stabilization of the banking system in early 1999, banks have reduced their use of the facilities. The amount of commercial bills held by the BOJ rose from about ¥10 trillion in September 1998 to about ¥14 trillion in December 1998 and then fell to about ¥3 trillion in May, while the size of the overall CP market remained broadly unchanged (Figure III.8). Similarly, BOJ lending under the refinancing facility—made available to ease financing at the end of the 1998 financial year—was only about one-quarter of the eligible amount, and the new corporate-bond backed operation has been used only lightly.

FIGURE III.8.
FIGURE III.8.

JAPAN: COMMERCIAL PAPER MARKET, 1997–99

(In billions of yen)

Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A003

Source: WEFA, Nomura database.

20. The BOJ measures had a limited impact on corporate financing beyond high-quality paper, because they were not principally directed at reducing corporate credit spreads. Although these facilities allowed the BOJ to enter the corporate debt market, they were structured to limit the transfer of credit risk onto its balance sheet.9 Thus, the underlying credit risk stayed off the BOJ’s balance sheet and in the private sector. To the extent that the BOJ’s operations had a limited impact on credit spreads, they also had little effect on firms’ cost of funds.

C. Remaining Options to Ease Monetary Policy

21. The current unusual situation with interest rates close to—and now effectively at—zero has generated intense debate about whether further steps could be taken to enhance the effectiveness of monetary policy. Proposals include the underwriting or increased purchases of government bonds, the announcement of an explicit inflation target, the adoption of a supplementary operating target, and less conventional operations, including the expansion of outright purchases of private sector securities and buying tangible assets.

22. In the face of rising government bond yields in early 1999, there were strong political pressures for the BOJ to underwrite government bonds, thus facilitating issuance and reducing upward pressure on long-term interest rates. However, BOJ officials have argued strongly that such a fundamental change in institutional structure, which at a minimum would require parliamentary approval of the activation of a special provision in the Public Finance Law, would carry a serious risk of weakening fiscal discipline.10 In turn, the prospect of larger government budget deficits and greater central bank financing could increase inflationary expectations, and thus raise long-term interest rates (see Hayami, 1999). The BOJ already has the authority to make outright purchases of government bonds on the secondary market, so-called rinban operations, which the BOJ conducts to match the rise in currency issue with increased holdings of government bonds. However, the BOJ argues that expanding such purchases in excess of currency issue could have the same effect on market expectations as underwriting.

23. Clarifying the inflation objective could enhance the effectiveness of monetary policy by reducing uncertainty about future price developments and focus the public policy debate. The BOJ has a legal mandate to achieve price stability, but this objective is not precisely defined, as it has been for some other central banks. By announcing an explicit inflation target, and publishing an inflation report and forecast, policymakers could help emphasize the essential forward-looking nature of monetary policy, with the inflation target as the intermediate goal. While the BOJ’s commitment to avoiding high inflation is not in doubt, an explicit inflation target could underline the BOJ’s intention to avoid deflation. For example, the period in late 1998 and early 1999, during which the BOJ did not react to a tightening of monetary conditions implied by an appreciating exchange rate, could have encouraged the perception that the BOJ may be less concerned by declining rather than rising prices. The announcement by the BOJ in April 1999 that it would “maintain the current zero interest rate policy until deflationary concerns are dispelled” can be understood as a message to the market underlining the BOJ’s determination to resist deflation.

24. With most of the necessary institutional arrangements for inflation targeting already in place, the main operational issue would be the specification of the inflation target. Following the implementation of the new Bank of Japan Law in April 1998, the monetary policy framework in Japan already has many of the characteristics that are typical of inflation targeting frameworks, including central bank independence, the primacy of the price stability objective, instrument independence, and policy decisions made by a monetary policy committee with regular meetings and published minutes. The crucial questions in the specification of the inflation target include the selection of a price index and setting a numerical target. Experience with inflation targeting in other industrial countries supports defining the inflation target in terms of a well-known and widely-used price index, such as the consumer price index, possibly excluding a few items subject to sharp transitory price movements not linked to domestic demand pressures. Care would be needed since, when inflation is already very low, the differences between alternative measures of inflation—such as the CPI, the CPI minus food and energy, or the deflator for personal consumption—can be large compared to the inflation rate.

25. If Japan were to adopt an inflation targeting approach, there would be several reasons to aim for a low positive inflation target. First, it may sometimes be useful for the real interest rate to be negative, such as during recessions (Fischer, 1994 and 1996). With zero as the lower bound for nominal interest rates, the real interest rate cannot be negative if expected inflation is zero or less (Summers, 1991).11 Second, in the presence of downward price inflexibility, positive inflation can reduce the output costs of adverse shocks to aggregate demand and facilitate the adjustment of relative prices. Third, the CPI in Japan—as in other countries—is biased upwards, owing primarily to the difficulties in fully capturing quality changes and the gradual shift to lower price stores. Shiratsuka (1999) estimates this bias to be about 1 percent.

26. Nevertheless, a number of difficulties arise in considering an inflation targeting approach for Japan. One concern is that the announcement of an explicit inflation target could reduce the BOJ’s flexibility in responding to shocks. The BOJ has multiple objectives, including maintaining price stability and ensuring the stability of the financial system so as to lay the foundations for sound economic development. In view of these multiple objectives, the BOJ might need to respond to unusual developments in asset prices, the exchange rate, or the financial system. There could be a risk that defining an inflation target could constrain the central bank to respond too mechanically to the wide variety of shocks that affect the economy. Another potential problem is that the discrepancy between the CPI and WPI inflation rates has been and continues to be particularly large in Japan, compared to other major industrial countries. This wide divergence makes it more difficult to choose a single representative price index.

27. With the overnight call rate now at its floor, the BOJ could consider adopting a supplementary operating target, so that it could signal a loosening of the policy stance, if this became necessary. Most central banks signal a change in the policy stance by adjusting their target for short-term interest rates. However, with short-term rates at their floor in Japan, such an approach can no longer be used. An alternative suggested by a number of commentators would be for the BOJ to announce a target for another variable, such as an intermediate interest rate or the monetary base, while keeping the overnight call rate as its primary operating target. Using an intermediate interest rate as a supplementary target would be relatively easy to integrate with the continued use of the call rate as the primary objective. In choosing an intermediate interest rate target, it would be necessary to move quite a long way out the yield curve, since the curve presently lies below 25 basis points all the way out to one year. A monetary base target could be derived from a projected path for nominal GDP adjusted for trend velocity and the deviation of actual nominal GDP from its projected path in the recent past (for the specification of such a target for Japan, see McCallum, 1993).

28. There are a number of issues that would need to be faced in using such an approach. Specifically, with respect to targeting medium- or long-term interest rates, it may be difficult for the BOJ to control such rates, because this requires influencing expectations of future short-term interest rates or term premia (or both), How can the BOJ change the market’s view of monetary policy several years in the future? For example, outright purchases of medium-term bonds would not necessarily change expectations of future short-term interest rates, because the increase in the monetary base associated with a bond purchase would not necessarily be sustained for any longer than that with a purchase of a Treasury bill. Also, while purchases of bonds could in principle reduce term premia if bonds and other assets are imperfect substitutes in the public’s portfolio, historical evidence from Operation Twist in the U.S. in 1961 does not suggest that these effects are large (Johnson, Small, and Tryon, 1999).

29. The implementation of a monetary base target would face important obstacles, including volatility in money base demand. The possibility of substantial shocks to the demand for currency or bank reserves implies that the monetary stance could turn out to be easier than expected, which—notwithstanding current deflationary pressures—could fuel inflation later on. Stronger-than-expected demand for base money would be revealed immediately in upward pressure on interest rates, which would be countered by the BOJ’s adherence to its primary operating target. However, weaker-than-expected demand for base money cannot put downward pressure on interest rates that are already at zero, so the monetary stance could—unknown to the BOJ—turn out to be more expansionary than planned. As a result, a supplementary base money target would either have to be revised frequently, which would reduce its usefulness as a signaling device, or—if rigidly adhered to—could increase uncertainty about future short-term interest rates and hence raise the volatility of longer-term interest rates.

30. Other potential problems are how to control base money and whether increases in base money affect aggregate demand when interest rates are zero. In principle, the demand for base money is indeterminate when interest rates are zero. In practice, recent experience has shown that most banks are reluctant to increase their excess reserves, preferring instead to place excess funds with money market brokers. Thus, there is no assurance that repeated injections of liquidity would in fact lead to an increase in base money. Moreover, even if an increase in base money could be engineered, it is not clear that this would have a large impact on aggregate demand. One could argue that sufficiently large injections of excess reserves would eventually spill into asset markets, such as the foreign exchange market and the stock market, or affect price expectations. However, this is largely uncharted territory, and it is not clear that such effects would be large.12

31. Finally, the BOJ could consider increasing monetary stimulus by expanding outright purchases of private sector securities and buying tangible assets. Substantial purchases by the BOJ would likely raise prices, which could have substantial wealth effects and thus stimulate economic activity. However, affecting the prices of tangible assets and private sector securities could be problematic on political and legal grounds—how should the BOJ decide which assets to purchase? Such purchases would be equivalent to distributing wealth to some citizens and not to others, based solely on their asset holdings. Moreover, it would expose the BOJ’s balance sheet to considerable credit risk. A better alternative—in an extreme deflationary situation—would probably be to affect the wealth distribution through reductions in taxes or increases in government spending or transfers, which would have the advantage of explicitly incorporating the political process, and have the BOJ finance the resulting increase in the government deficit, i.e., money financed expansionary fiscal policy. While the direct financing of the government deficit by the BOJ is generally prohibited by law (as discussed above), this restriction can be lifted temporarily in extreme circumstances.

References

  • Fischer, Stanley, “Modern Central Banking,” in Forrest Capie, Charles Goodhart, Stanley Fischer, and Norbert Schnadt (eds.), The Future of Central Banking, (Cambridge: Cambridge University Press), 1994.

    • Search Google Scholar
    • Export Citation
  • Fischer, Stanley, “Why are Central Banks Pursuing Long-Run Price Stability?” in Achieving Price Stability, Federal Reserve Bank of Kansas City, 1996.

    • Search Google Scholar
    • Export Citation
  • Hayami, Masaru (Governor of the Bank of Japan), “On Recent Monetary Policy,” Speech at the Japan National Press Club (English translation on BOJ website (www.boj.or.jp)), June 22, 1999.

    • Search Google Scholar
    • Export Citation
  • Johnson, Karen, David Small, and Ralph Tryon, “Monetary Policy and Price Stability,” paper prepared for a conference at the Austrian National Bank, June 1011, 1999

    • Search Google Scholar
    • Export Citation
  • Krugman, Paul R., “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity, 2, pp. 137205, 1998.

    • Search Google Scholar
    • Export Citation
  • Lipworth, Gabrielle, and Guy Meredith, “A Reexamination of Indicators of Monetary and Financial Conditions,” in Bijan B. Aghevli, Tamim Bayoumi, and Guy Meredith (eds.), Structural Change in Japan: Macroeconomic Impact and Policy Challenges, (Washington: International Monetary Fund), 1998.

    • Search Google Scholar
    • Export Citation
  • McCallum, Bennett, “Specification and Analysis of a Monetary Policy Rule for Japan,” Monetary and Economic Studies, Bank of Japan, 11:2 pp. 160, November 1993.

    • Search Google Scholar
    • Export Citation
  • Shiratsuka, Shigenori, “Measurement Errors and Quality Adjustment Methodology: Lessons from the Japanese CPI,” Economic Perspectives, Federal Reserve Bank of Chicago, Second Quarter 1999.

    • Search Google Scholar
    • Export Citation
  • Summers, Lawrence, “How Should Long-Term Monetary Policy Be Determined?Journal of Money, Credit, and Banking, 23:2 pp. 62531, August 1991.

    • Search Google Scholar
    • Export Citation
1

Prepared by James Morsink (ext. 37875).

2

The monetary conditions index is a weighted average of the short-term interest rate and the exchange rate (see Lipworth and Meredith, 1998), While it is usually based on real values of both variables, the nominal version may be calculated with a shorter lag and at a higher frequency.

3

Nominal interest rates cannot fall below zero because cash is an alternative store of value. When Treasury bill yields and some interbank rates fell momentarily below zero in November 1998, investors rapidly shifted into other assets and the yields quickly became positive again.

4

The slight pickup in broad money growth in the second half of 1998 was driven in part by the buildup of precautionary deposits by corporations, which feared an intensification of the credit crunch, but growth has subsequently subsided as liquidity fears have been relieved.

5

The adjusted data are not included in Figure III.6 as they are only available starting in October 1998.

6

Further analysis of the monetary transmission mechanism is provided in the 1999 Selected Issues paper by Morsink and Bayoumi.

7

Some banks are reported to have initially encouraged loan officers to use the loan guarantee program to refinance bad loans, but the FSA discouraged this practice.

8

The injection of public funds and banks’ capital strength are discussed in the accompanying chapter on banking system issues.

9

For example, in CP repurchase operations, the CP must be endorsed by the seller, i.e., the BOJ’s counterpart, typically a bank.

10

Japan’s experience with high inflation in the immediate post-World War II period (called “vicious inflation”) led to a general legal prohibition on the central bank underwriting of government bonds.

11

Going further, given the severity of Japan’s economic downturn last year, Krugman (1998) suggested adopting an inflation target of 4 percent for 15 years in order to achieve the reduction in the real interest rate necessary to close the output gap. However, a target of 4 percent is higher than those chosen by other industrial countries with inflation targeting and raises questions about the costs of inflation at this level. Also, it is not clear how a central bank in an economy that is in a liquidity trap—where increases in the monetary base have no direct effect on aggregate demand—can credibly commit to generate inflation in the short term or how it can credibly commit to maintaining this policy in the long term.

12

The paper by Morsink and Bayoumi in the 1999 Selected Issues paper finds that increases in base money have a limited impact on economic activity after changes in the overnight call rate are taken into account.

Japan: Economic and Policy Developments
Author: International Monetary Fund