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Unformatted text preview: dically intervention looked unsterilised, as the amount of intervention and changes in monetary base were running neck to neck (see Ito, forthcoming). For example, the accumulated intervention and increase in money supply were, respectively, 2.3 trillion yen and 1.7 trillion yen for 2003:Q1; 4.5 trillion yen and 6.1 trillion yen for 2003:Q2; 7.5 trillion yen and 0.9 trillion yen for 2003:Q3; and 5.9 trillion yen and 3.9 trillion yen for 2003:Q4. For calendar year 2003, accumulated intervention was 20 trillion yen and the increase in monetary base was 12.6 trillion yen. But, if the increase in the monetary base of 9.2 trillion for 2002:Q4 (when there was no intervention) was added to the increase in the monetary base, the two figures become about equal for the period from 2002:Q4 through 2003:Q4. Although the correspondence was most likely a coincidence rather than planned, it did provide a signal of the Banks willingness to cooperate. (In 2004:Q1 there was another 15 trillion yen worth of intervention while the monetary base increased by less than 1 trillion yen.) In September 1999 any suggestion of unsterilised intervention was strongly Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting? 241 rejected by the Bank, while in 2003 Deputy Governor Iwata himself pointed out the correspondence, although he concluded that it must be a coincidence.27 3. Inflation Targeting In this section the pros and cons of adopting inflation targeting in general, and under the deflationary environment in Japan in particular, are considered. The Bank of Japan (including most Board members and staff economists) has consistently argued against the adoption of inflation targeting, and that is a major reason why inflation targeting has not been introduced. Reasons that have been expressed by the Bank of Japan for not adopting inflation targeting are examined in the discussion below. In the following I will not make sharp distinctions between inflation targeting and price-level targeting, unless necessary. 3.1 Inflation targeting proposals from academics Inflation targeting was proposed in Japan in the context of fighting deflation and the (near-) zero interest rate. One of the problems associated with the (near-) zero interest rate bound is that as deflationary expectations deepen, the real interest rate increases. The higher real interest rate discourages investment and consumption and exacerbates the deflation problem. Therefore, in order to break the deflationary cycle, many economists thought that managing expectations was very important. Krugman (1998) was probably the first to suggest some sort of inflation targeting. The essence of his argument was that the Bank of Japan had to promise a high inflation rate later to influence inflation expectations. Raising expectations regarding inflation helps to stimulate current economic activity by reducing the real interest rate, As the commitment device, he proposed an inflation target. After some calibration, he called for 4 per cent inflation for 15 years. Ito (1999, 2001) proposed that the Bank of Japan adopt inflation targeting. As an independent central bank, accountability is needed, and inflation targeting is beneficial in that regard. It would also enhance instrument independence. Moreover, inflation targeting is an effective way to influence inflation expectations. With a zero interest rate, changing inflation expectations is the most effective way to avoid high real interest rates.28 Svensson (2001) presented his foolproof way of escaping the liquidity trap at the Bank of Japan conference in July 2000. The paper recommended fixing the exchange rate at the depreciated yen/dollar rate until the price level catches up with the target, and then allowing the yen to float again. The kick-start for inflation comes from depreciation of the yen, and price-level targeting spells out the exit condition.
27. Press interview, 1 October 2003 in Sendai. The original is available in Japanese at <http://www.boj.or.jp/press/03/kk0310a.htm>. 28. The newspaper opinion piece by Ito (1999) was answered by a Bank economist, Okina (1999b), in the same space. A Board member, Ueda (2000), supported Okinas view several months later in another opinion piece. 242 Takatoshi Ito McCallum (2000, 2003), Meltzer (2001), Bernanke (2003) and Eggertsson and Woodford (2003) also offered advice to the Bank of Japan broadly in line with an expansion of the monetary base with a resulting depreciation of the yen, and/or some form of inflation targeting or price-level targeting. See Svensson (2003) and Ito and Mishkin (2004) for a survey of this literature. Ito and Hayashi (2004) argued for the desirability of adopting inflation targeting. Ito and Mishkin (2004), among other things, advocated a particular type of inflation target, namely the price level target in order to make monetary policy more pathdependent. Many economists recommended that the Bank of Japan announce a low but positive...
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