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Unformatted text preview: od is that, monetary policy operations linked with control of the foreign exchange rate runs a risk of leading to erroneous policy decisions. Having said this, it does not mean that monetary policy is pursued without any consideration to the development of the foreign exchange rate. The Bank considers it important to carefully monitor the development of the foreign exchange rate from the viewpoint of how it affects the economy and prices (Bank of Japan, On the current monetary policy, 21 September 1999). Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting? 233 was not a useful concept for a central bank that watches total funds in the market, whatever various sources they came from.20 The Board indicated that it had done enough to ease monetary conditions, and it even cited the side-effects of the ZIRP. The Board also challenged the market expectation that non-sterilised intervention would be pursued. This was indicative of their desire to end the ZIRP as soon as possible.21 No additional easing was adopted between the fall of 1999 and the summer of 2000, except for liquidity injections to deal with Y2K concerns. In the spring of 2000, Governor Hayami started to suggest that the ZIRP may end soon, as the economy showed some signs of recovery. Stock prices in particular were suggesting a rosier situation: ICT-related stock prices had soared, some tripling in a year, and the Nikkei 225 index had increased by 30 per cent between March 1999 and March 2000. Corporate profits rose and corporate investment started to increase. Some Bank economists suggested that these corporate earnings would trickle down to households to stimulate consumption sooner or later.22 This argument was dubbed the dam theory: water (profits) was filling up the corporate dam and would overflow to downstream (households income) sooner or later. By June, Governor Hayami was frequently suggesting that there were bright signs in the economy so that the ZIRP could, and should, be ended soon. Yet many economists thought that ending the ZIRP would be premature. They called for an easing of monetary policy, or quantitative easing, while the Bank of Japan was looking at a tightening of monetary policy not a healthy situation. The ZIRP was indeed lifted on 11 August 2000, as the Board decided that the deflationary concern was over. 23 However, it was realised at this time that the further recovery of the Japanese economy was in doubt. First, the ICT bubble had already burst, and ICT stock prices in the US and Japan had already crashed, suggesting
20. In relation to the foreign exchange rate policy, we have heard arguments in favor of non-sterilised intervention. In the reserve market, however, there are various flows of funds such as currency in circulation and Treasury funds other than those resulting from the intervention. The Bank conducts its daily market operations taking into account all the money flows, in order to create ample reserves to such an extent as described above. This strong commitment of fund provision is consistent with the governments current foreign exchange rate policy (Bank of Japan, On the current monetary policy, 21 September 1999). 21. The Bank views the current state of the Japanese economy as having stopped deteriorating with some bright signs, though a clear and sustainable recovery of private demand has yet to be seen. In pursuing the zero interest rate policy, we need to carefully examine its adverse side-effects, but deem it important to support the economic recovery by continuing easy monetary policy for the periods ahead (Bank of Japan, On the current monetary policy, 21 September 1999). 22. Currently, it is our judgment that Japans economy is at the stage where the number of firms taking the offensive has started increasing, that is, the economy is moderately recovering parallel with structural adjustment ... with respect to the recovery of private demand, it seems natural that the corporate sector, which has regained profitability as a result of restructuring, should take the lead by increasing investment followed by the household sector as income conditions gradually improve. This is the development we are now witnessing (Hayami 2000b). 23. Governor Hayami intended to raise the interest rate in July. However, a large department store, Sogo, failed and the economy showed some weakness. The plan to lift the interest rate was postponed without being submitted to the meeting. 234 Takatoshi Ito investment and consumption would be adversely affected in the near future. Second, the US economy was decelerating. Third, and most importantly, the inflation rate was still negative and projected to be negative for at least a year. How could the Bank of Japan tighten policy when the inflation rate was negative? The government disagreed with the Bank on the outlook for the economy and the appropriateness of raising the interest rate, and motioned that the vote to repeal the ZIRP should be delayed. Putting...
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This note was uploaded on 05/12/2010 for the course COMMERCE finc at University of Sydney.