Unformatted text preview: e (2003) proposed that the government substitute the straight bonds that the Bank of Japan holds with floating-rate government bonds, in order to protect the Banks balance sheet from the interest rate risk. 41. This point was made by Robert McCauley during this conference. 42. See Ito (2003) for the institutions of foreign exchange intervention in Japan, and Ito (forthcoming) for intervention records in 20032004. 252 Takatoshi Ito 4. Concluding Remarks Advocates of inflation targeting have put forward basically three reasons why inflation targeting was a good idea: accountability and transparency; instrument independence; and effects on inflation expectations. For the third reason, it is particularly desirable for the Bank of Japan to adopt inflation targeting in a deflationary environment, as advocates have argued. However, inflation targeting has not been adopted, although some quantitative easing measures that were resisted in early years have been. In examining the reasons put forward by opponents of inflation targeting, it has been shown that, for each item of opposition, there are good rebuttals. Opponents of inflation targeting seem to have prevailed for political economy reasons. Inflation targeting was not adopted in Japan in the early years (the first wave, 19992000) because the Board members were not sure which price index would be best, and whether a specific number for an appropriate inflation rate could be determined. A study, commissioned in March 2000, and completed in October 2000, did not give any clear answers to this, and the Bank missed the opportunity. Inflation targeting was not adopted in later years (20012003), despite the inflation-targetinglike commitment strategy adopted in March 2001, because the Board members thought that conventional tools to increase the inflation rate were not available. As such, announcing a target with a positive inflation rate would damage confidence just announcing inflation targeting would not increase the inflation rate. In terms of introducing unconventional measures, the Bank of Japan worried about the transmission channels and the damage to its balance sheet. Towards the end of Governor Hayamis term, the views against inflation targeting turned sharply negative, as news reports suggested that it may be linked to the new Governors appointment. Therefore, why inflation targeting was not adopted, can be explained and understood from a political economy perspective. This paper explained why the Bank of Japan hesitated to adopt inflation targeting. In other countries, the adoption of inflation targeting and the setting of a specific numerical target is often done by the Treasury (Ministry of Finance) or by consultation between the Treasury and the central bank. Another question is why the Ministry of Finance did not formally propose the adoption of inflation targeting to the Bank of Japan. One possible explanation is that officials at the Ministry of Finance thought that if the government set the goal that would be viewed as a violation of central bank independence. However, the literature and practice in other countries, such as Australia, New Zealand and the United Kingdom, show that goal independence is not an essential part of central bank independence. On the contrary, government involvement in setting the target is considered to be a good way of achieving coordination between fiscal and monetary policy. Another possible explanation for why the Ministry of Finance was not pushing the Bank of Japan to introduce inflation targeting was that the Ministry feared that the long-term interest rate would go up sharply if inflation targeting was adopted (see Section 3.4.6). As of writing this paper, the Japanese economy seems finally to be getting out of its long stagnation. If the current strength in the economy continues, there is a Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting? 253 chance that deflation could be overcome in coming months, rather than years. The necessary conditions to exit from the ZIRP that is, positive inflation rates backward and forward have been clearly stated since October 2003. When the exit from deflation and the ZIRP is achieved, that will be the beginning of a new regime for the Bank of Japan. One of the obstacles to adopting inflation targeting that is, there are no instruments to achieve positive inflation rates at the ZIRP will be gone. In order to facilitate accountability in the post-ZIRP area, inflation targeting should be given serious thought. Preparation should be started sooner rather than later. 254 Takatoshi Ito Appendix: Inflation Targeting as Discussed in Monetary Policy Meetings (MPM) A Chronological Review43
Inflation targeting was first discussed by the Board on 16 July 1998. One member remarked that inflation targeting was worth considering as it could work on peoples expectation ... in an extremely severe economic situation in which an optimal monetary policy was to realise negati...
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