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Unformatted text preview: he nominal interest rate hike per se is not damaging, but the real interest rate hike is. When the economy is in a depressed state, it is more likely that the increase in inflation expectations at the long end of the yield curve would result in a reduction, not an increase, in the real interest rate. 3.4.7 No additional instruments at the zero interest rate
The opposition to inflation targeting in Japan boils down to the feasibility of adopting available instruments. Those who oppose inflation targeting always raise the issue of no tools being available at the zero interest rate.37 Given that the interest rate is zero, no policy measures are available to lift the inflation rate to positive territory, so that the announcement of inflation targeting, without tools to achieve the target, would damage the credibility of the Bank. Therefore, committing to a target when the Bank did not have the tools to achieve it would cause the Bank to lose credibility.38 Advocates have argued that several unconventional instruments, including quantitative easing and aggressive purchases of riskier assets, are available, even at the zero interest rate. Under the guise of quantitative easing, long-bond purchases
36. This view was frequently mentioned in MPMs and also in speeches. For example, see the MPMs on 28 June 1999 and 10 October 2002. The view was also expressed by Hayami (2000a). 37. This view was expressed throughout the period of the Hayami regime by Board members and Bank economists. Early citations include the MPMs on 13 October 2000 and 12 July 2001. See also Oda and Okina (2001, pp 352356). 38. [T]he BOJ argues, as is recorded in the minutes of Monetary Policy Meetings, that "since we cannot explicitly show the way to achieve the desired inflation rate, such action would most likely result in the BOJ losing credibility" (Okina 1999a, p 165). In response, critics argued that as nonconventional monetary policy measures exist that could achieve a positive rate of inflation, the credibility argument is based on incorrect assumptions. Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting? 251 and increasing the monetary base have been implemented since March 2001. Prior to this, Board members were sceptical about the effectiveness of quantitative easing. In addition, buying foreign bonds, market-based stock index funds, and listed realestate trust funds are frequently mentioned as potential measures. The debate would then shift to the appropriateness of unconventional measures. This debate is not covered here, but Ito and Mishkin (2004) provide a survey of the literature, and Ahearne et al (2002) and Bernanke (2002) discuss unconventional instruments in the context of the Federal Reserve Board.39 One of the concerns with unconventional policy purchasing stocks, foreign bonds and real estate was the possible damage to the Bank of Japans balance sheet. Prices of risky assets may go down, and the Banks capital may be depleted and credibility would be lost. Advocates of unconventional policies argued that the Banks balance sheet was not a concern; if the Bank is regarded as a part of the public sector, the consolidated balance sheet with the government would not show a problem. In the extreme case, a capital injection from the government is possible. If inflation targeting had been adopted, it would also be easier to justify the Banks action of purchasing risky assets. The government would inject capital, as long as the inflation target is met, without asking questions. Thus an additional benefit of inflation targeting, from the accountability viewpoint, is that it would enable the Bank to take bold actions.40 Some of these instruments, as they are in the realm of fiscal policy, need the cooperation of the Ministry of Finance.41 Foreign exchange intervention is decided and conducted by the Ministry of Finance in Japan.42 Most of the foreign reserves in Japan are held in the special account of the government. So, the central bank purchase of foreign bonds can only be achieved by intervention by the Ministry of Finance with an equivalent increase in monetary base. Any short-term government bonds are essentially absorbed by the Bank of Japan, so long as the ZIRP is maintained. As such, so-called helicopter money can be dropped into the economy by way of a tax cut financed by the government issuing short-term government bonds. So, at the zero interest rate, the line between monetary policy and fiscal policy is blurred. It is thus essential that the Bank of Japan and the Ministry of Finance cooperate to achieve a common goal, namely getting out of deflation. 39. See Fujiki et al (2001) for the Bank of Japans view. Views from the US on the Japanese experience are available in Ahearne et al (2002) and Clouse et al (2000). 40. Currently, most of the risk in the Banks balance sheet arises from the long-term government bonds it holds. An increase in the long-term interest rate would cause unrealised capital losses in these long bonds. Bernank...
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This note was uploaded on 05/12/2010 for the course COMMERCE finc at University of Sydney.