3.NewBankof Japan3.1Monetary policy of the Hayami regime,1998-2003When the newly independent Bank of Japan started in April 1998, hopes were high in thattheBank of Japan would improve its performance and return to what had been viewed as successfulmonetary policy in the preceding two decades.However, after five years under the Hayami regime,the Bank of Japan has lost credibility and suffered a serious confidence problem.What happened?Theshort answers to these questions are two-fold.First, the Policy Board members, led by GovernorHayami, misjudged the economic conditions, maybe because they were too eager to go back to the"normal"situation where the interest rate is positive.The interest rate hike in August 2000 was aclear mistake of this kind.Second,the Governor and fellow Board members took independenceliterallyand refused tocooperatewith the Governmentwhen the economic conditions calledfor suchcooperation.Sinceindependenceand early establishmentofcredibilitywereconsidered so importantpolicy actions became conservative, timid, and tentative. Cargill, Hutchison, and Ito (2000: p. 173)called this the"independence trap."Even when policy was finally directed toward quantitativeeasing in March 2001,this policywas notexplained adequately,especially because theBank of Japanhad claimed that it was likely to be ineffective. Therefore the general public viewed the Bank ofJapan as adoptingapolicy that theBank did notbelieve in.That washardlyagood way ofcommunicating with themarket.TheoldBank of Japan,underthe1942Law,was supposedtopursuemonetarypolicyinorderto maximize economic potential (notprice stability),and the Governor could be replaced by theMinister of Finance, if the Governor did not follow the government instructions.7A lack ofindependence is often cited as a causefor an unusually high inflation rate, about 30%,in 1973-74, inthe wake of the first oil crisis.After the inflation of 1973-74,theBank of Japan had conductedprudent monetary policy, achieving a gradual decline in the inflation rate.Cargill, Hutchison, and Ito(1997;Chapter 8)have praised the conduct of the Bank of Japan,achieving a defacto independencebased on reputation. Japan was known to have been an“outlier"in the relationship between the legalindependence index and the historical inflation rate.The newlawtheBank of Japan Law of 1998,guaranteed the independence of theBank ofJapan in its policy making and Board member appointments.The law became effective on April 1,7The1942 Law specified that the Bank of Japan conducts its operation"in order that the general economicactivities of the nation might adequately be enhanced(Article I).The objective of the Bank of Japan was"forachievementofnationalaims(Article2).Thesewordingsshouldbeunderstoodinthecontextofthewar when the bill was passed. See Cargill, Hutchison, and Ito (2000: chapter 4) for detailed comparison oftheoldand newBankof Japan Laws8The1998Lawspecifiestwopillars,"thepursuitofpricestability,contributingtothesounddevelopmentof the national economy (Article 2),"and"maintenance of an orderly financial system(Article I)."Theabsence of mentioningfull employment, economic growth,orexchangerate objectives suggests that pricestability is the primary objective.Financial system stability is a shared responsibility with government.10
10 3. New Bank of Japan 3.1 Monetary policy of the Hayami regime, 1998-2003 When the newly independent Bank of Japan started in April 1998, hopes were high in that the Bank of Japan would improve its performance and return to what had been viewed as successful monetary policy in the preceding two decades. However, after five years under the Hayami regime, the Bank of Japan has lost credibility and suffered a serious confidence problem. What happened? The short answers to these questions are two-fold. First, the Policy Board members, led by Governor Hayami, misjudged the economic conditions, maybe because they were too eager to go back to the “normal” situation where the interest rate is positive. The interest rate hike in August 2000 was a clear mistake of this kind. Second, the Governor and fellow Board members took independence literally and refused to cooperate with the Government when the economic conditions called for such cooperation. Since independence and early establishment of credibility were considered so important, policy actions became conservative, timid, and tentative. Cargill, Hutchison, and Ito (2000: p. 173) called this the “independence trap.” Even when policy was finally directed toward quantitative easing in March 2001, this policy was not explained adequately, especially because the Bank of Japan had claimed that it was likely to be ineffective. Therefore the general public viewed the Bank of Japan as adopting a policy that the Bank did not believe in. That was hardly a good way of communicating with the market. The old Bank of Japan, under the 1942 Law, was supposed to pursue monetary policy in order to maximize economic potential (not price stability), and the Governor could be replaced by the Minister of Finance, if the Governor did not follow the government instructions. 7 A lack of independence is often cited as a cause for an unusually high inflation rate, about 30%, in 1973-74, in the wake of the first oil crisis. After the inflation of 1973-74, the Bank of Japan had conducted prudent monetary policy, achieving a gradual decline in the inflation rate. Cargill, Hutchison, and Ito (1997; Chapter 8) have praised the conduct of the Bank of Japan, achieving a de facto independence based on reputation. Japan was known to have been an “outlier” in the relationship between the legal independence index and the historical inflation rate. The new law, the Bank of Japan Law of 1998, guaranteed the independence of the Bank of Japan in its policy making and Board member appointments. 8 The law became effective on April 1, 7 The 1942 Law specified that the Bank of Japan conducts its operation “in order that the general economic activities of the nation might adequately be enhanced” (Article 1). The objective of the Bank of Japan was “for achievement of national aims” (Article 2). These wordings should be understood in the context of the war when the bill was passed. See Cargill, Hutchison, and Ito (2000: chapter 4) for detailed comparison of the old and new Bank of Japan Laws. 8 The 1998 Law specifies two pillars, “the pursuit of price stability, contributing to the sound development of the national economy (Article 2),” and “maintenance of an orderly financial system (Article 1).” The absence of mentioning full employment, economic growth, or exchange rate objectives suggests that price stability is the primary objective. Financial system stability is a shared responsibility with government
1998.At around the same time, Mr. Hayami was appointed as Govemor, and Mr. Yamaguchi and MrFujiwara two deputy governors.Two policy board members were carried over from the old lawregime, butfour new members were appointed in April 1998 to replace the old members and vacancy.Mr.Hayami,age72 at thetimeofnew Governor appointment, left the Bank of Japan, after serving for34 years on the international side of the Bank, in 1981 (17 years earlier) to go to a general tradingcompany, Nissho-Iwai.After serving as President and Chairman of Nissho-Iwai, he had retired fromthe companyfor several years,until he returned to theBank of Japan as Governor.Deputy GovernorYamaguchi had climbed up the ladder in the Bank of Japan,with a reputation for his knowledge aboutthe core business of central banking.Deputy Governor Fujiwara was former journalist.GovernorHayami was brought back to the top position,partly because he was considered to be incorruptible inthe wake of a scandal at the Bank of Japan.The Japanese economy inthespring of 1998 was intheprocess of falling intoa seriousrecession and financial instability.In November 1997, financial instability became prominent: onelarge bank and one small bank, a large securities firm, and a medium-size securities firm all failed, andcredit lines among the Japanese financial institutions,and between western financial institutions andJapanese financial institutions became severely limited.The Asian financial crisis was spreadingfrom Thailand to Indonesia, to Korea, and to the region in general. Demand was falling and it wasclear that the economy was heading into a recession.io The overnight call rate, the market ratecorresponding to the Federal Funds rate in the United States, at the time was about 0.4-0.5%.Thisstance was maintained until September 9, 1998, when the target of the call rate was reduced to0.25%.1Another major step was taken in February 12,1999.The Board decided to lower theovernight call rate as low as possible, with an immediate action to lowerit to 0.15%.2This is the9 Many Bank officials were implicated for inappropriate behavior of dining and golfing with private-sectorpeople.Thescandalhitthemediaparticularlyhard inthefirstthreemonthsof1997.Highsalaries,highseverancepayandlargecompanyhousingwerealsobecameatargetofcriticism.OneBankofficialwasarrested for taking bribes in return for leaking information to a securities firm.Governor Matsushita and,DeputyGovernorFukui (whoreturnedasGovernorfiveyearslater)resigned totakeresponsibilityinMarch1998,daysbeforethenewBOJlawtookeffect.Theofficialwhotookbribeswasdismissedfromthe Bank on April 3, 199810 In the spring of 1998, it was announced that the economy had just experienced the two-consecutivequartersofnegativegrowthrates:-0.7%in1997:1Vand-0.3%in1998:1.ThecurrentlyavailablenewSNA93 (System of National Accounts,following a United Nations recommendation of 1993)(http://www.esri.cao.go.jp/jp/sna/qe034-2/gdemenuja.html) does not show this: +0.7% in 1997:1V and-1.0% in 1998:1. The difference is due to the differences in the base year, the estimation methods, and theseasonal adjustment method.The point is that the Bank of Japan and thegovernment should have had amore negative assessment of the economy at the time of Spring 1998.11 The Policy Board determined to further ease the stance of money market operations for theinter-meetingperiodaheadasfollows:TheBankofJapanwillencouragetheuncollateralizedovernightcallrate tomoveon average around 0.25%.(Bank of Japan,Announcement of Decisions,September9,1998)12The Bank of Japan will provide more ample funds and encouragethe uncollateralized overnightcallratetomoveaslowaspossible.Toavoidexcessivevolatility intheshort-termfinancialmarkets,theBank11
11 1998. At around the same time, Mr. Hayami was appointed as Governor, and Mr. Yamaguchi and Mr. Fujiwara two deputy governors. Two policy board members were carried over from the old law regime, but four new members were appointed in April 1998 to replace the old members and vacancy. Mr. Hayami, age 72 at the time of new Governor appointment, left the Bank of Japan, after serving for 34 years on the international side of the Bank, in 1981 (17 years earlier) to go to a general trading company, Nissho-Iwai. After serving as President and Chairman of Nissho-Iwai, he had retired from the company for several years, until he returned to the Bank of Japan as Governor. Deputy Governor Yamaguchi had climbed up the ladder in the Bank of Japan, with a reputation for his knowledge about the core business of central banking. Deputy Governor Fujiwara was former journalist. Governor Hayami was brought back to the top position, partly because he was considered to be incorruptible in the wake of a scandal at the Bank of Japan. 9 The Japanese economy in the spring of 1998 was in the process of falling into a serious recession and financial instability. In November 1997, financial instability became prominent: one large bank and one small bank, a large securities firm, and a medium-size securities firm all failed, and credit lines among the Japanese financial institutions, and between western financial institutions and Japanese financial institutions became severely limited. The Asian financial crisis was spreading from Thailand to Indonesia, to Korea, and to the region in general. Demand was falling and it was clear that the economy was heading into a recession. 10 The overnight call rate, the market rate corresponding to the Federal Funds rate in the United States, at the time was about 0.4-0.5%. This stance was maintained until September 9, 1998, when the target of the call rate was reduced to 0.25%. 11 Another major step was taken in February 12, 1999. The Board decided to lower the overnight call rate as low as possible, with an immediate action to lower it to 0.15%. 12 This is the 9 Many Bank officials were implicated for inappropriate behavior of dining and golfing with private-sector people. The scandal hit the media particularly hard in the first three months of 1997. High salaries, high severance pay and large company housing were also became a target of criticism. One Bank official was arrested for taking bribes in return for leaking information to a securities firm. Governor Matsushita and, Deputy Governor Fukui (who returned as Governor five years later) resigned to take responsibility in March 1998, days before the new BOJ law took effect. The official who took bribes was dismissed from the Bank on April 3, 1998. 10 In the spring of 1998, it was announced that the economy had just experienced the two-consecutive quarters of negative growth rates: -0.7% in 1997:IV and –0.3% in 1998:I. The currently available new SNA93 (System of National Accounts, following a United Nations recommendation of 1993) (http://www.esri.cao.go.jp/jp/sna/qe034-2/gdemenuja.html) does not show this: +0.7% in 1997:IV and –1.0% in 1998:I. The difference is due to the differences in the base year, the estimation methods, and the seasonal adjustment method. The point is that the Bank of Japan and the government should have had a more negative assessment of the economy at the time of Spring 1998. 11 “The Policy Board determined to further ease the stance of money market operations for the inter-meeting period ahead as follows: The Bank of Japan will encourage the uncollateralized overnight call rate to move on average around 0.25%. (Bank of Japan, Announcement of Decisions, September 9, 1998) 12 “The Bank of Japan will provide more ample funds and encourage the uncollateralized overnight call rate to move as low as possible. To avoid excessive volatility in the short-term financial markets, the Bank
beginning of the so-called zero interest rate policy (ZIRP).It was clear that the economy was in averyweak state.Atthetime,theGDPgrowthratewas thoughtto have shrunkforfive consecutivequarterssince1997:1V.13By the spring of 1999,the decline in economic activity became clearer-the instability ofthe Japanese financial system became acute as the Long-term Credit Bank teetered on bankruptcy;bills to strengthen the financial system were debated in the Diet; and the international financial systemwas shaken by the de facto default of the Russian debts in August.4After ZIRP was adopted, the Board members were divided into three groups,according tothe disclosed minutes.Ms. Shinotsuka, who opposed adopting ZiRP,thought that the interest rateshould be raised, partly to help pensioners.Mr.Nakahara, who had proposed lowering the interestratemore aggressivelythan other members beforeFebruary,frequently putforward a motion to adoptquantitative easing and inflation targeting,as actions beyond ZIRP.Both proposals were voted downwith only 1 vote in favor.The majority did not recognize the need to adopt any further actionsbetween February and September.Sincetheeconomy was notrespondingto the low interestrate,thegovernmentand businesssectors began topress the BankofJapan to adoptmore aggressive quantitative easing.Justbefore theSeptember 21, 1999 meeting of the Policy Board, speculations were abundant in press predicting thatthePolicy Board would adopt some sortof quantitative easing,possibly non-sterilized intervention inthe foreign exchange market in cooperation with the Ministry of Finance.The market regarded thatnon-sterilized intervention to be a signal that the Bank of Japan would fight deflation withunconventional measures.The markets also focused on whether the Bank of Japan would increasethe amount of money market liquidity on the settlement day that was two days after the intervention.ThePolicy Board reacted stronglyto this speculation in the press.TheBoard issued thestatement, in addition to a brief announcement of the monetary policy decision, at the conclusion ofthe meeting, instead of waitingfor quick minutes to be released two days later.In the announcementthe Board emphasized that monetary policy would not respond to exchange rate movements, thatnon-sterilized intervention was not a useful policy, and that the press was greatly mistaken in itsreports on what would happen at the up-coming meeting. The Board indicated that it had done enoughin easing monetary conditions,and itbarely concealed thedesireto goback to thepositiveinterestratebyemphasizingthe“"side-effects"of ZIRP.of Japan will, by paying due consideration to maintaining marketfunction, initially aim to guide the abovecall ratetomovearound0.15%,andsubsequentlyinducefurtherdecline inviewofthemarketdevelopments."(Bankof Japan,AnnouncementofDecisions,February12,1999)13 At the time of spring 1999, the growth rates of five quarters from 1997:1V through 1998:1V wereestimated as negative.The current (spring of 2004) estimates for the same period are 0.7,-1.0, -1.1, 0.8andO.l.Thereasonsforthedifferenceareexplainedintheearlierfootnote.14 Some speculatethat there was also implicit political pressurefromthe meetingbetween theFinanceMinister of Japan and the US Treasury secretary on September4.12
12 beginning of the so-called zero interest rate policy (ZIRP). It was clear that the economy was in a very weak state. At the time, the GDP growth rate was thought to have shrunk for five consecutive quarters since 1997:IV. 13 By the spring of 1999, the decline in economic activity became clearer – the instability of the Japanese financial system became acute as the Long-term Credit Bank teetered on bankruptcy; bills to strengthen the financial system were debated in the Diet; and the international financial system was shaken by the de facto default of the Russian debts in August. 14 After ZIRP was adopted, the Board members were divided into three groups, according to the disclosed minutes. Ms. Shinotsuka, who opposed adopting ZIRP, thought that the interest rate should be raised, partly to help pensioners. Mr. Nakahara, who had proposed lowering the interest rate more aggressively than other members before February, frequently put forward a motion to adopt quantitative easing and inflation targeting, as actions beyond ZIRP. Both proposals were voted down with only 1 vote in favor. The majority did not recognize the need to adopt any further actions between February and September. Since the economy was not responding to the low interest rate, the government and business sectors began to press the Bank of Japan to adopt more aggressive quantitative easing. Just before the September 21, 1999 meeting of the Policy Board, speculations were abundant in press predicting that the Policy Board would adopt some sort of quantitative easing, possibly non-sterilized intervention in the foreign exchange market in cooperation with the Ministry of Finance. The market regarded that non-sterilized intervention to be a signal that the Bank of Japan would fight deflation with unconventional measures. The markets also focused on whether the Bank of Japan would increase the amount of money market liquidity on the settlement day that was two days after the intervention. The Policy Board reacted strongly to this speculation in the press. The Board issued the statement, in addition to a brief announcement of the monetary policy decision, at the conclusion of the meeting, instead of waiting for quick minutes to be released two days later. In the announcement, the Board emphasized that monetary policy would not respond to exchange rate movements, that non-sterilized intervention was not a useful policy, and that the press was greatly mistaken in its reports on what would happen at the up-coming meeting. The Board indicated that it had done enough in easing monetary conditions, and it barely concealed the desire to go back to the positive interest rate by emphasizing the “side-effects” of ZIRP. of Japan will, by paying due consideration to maintaining market function, initially aim to guide the above call rate to move around 0.15%, and subsequently induce further decline in view of the market developments.” (Bank of Japan, Announcement of Decisions, February 12, 1999) 13 At the time of spring 1999, the growth rates of five quarters from 1997:IV through 1998:IV were estimated as negative. The current (spring of 2004) estimates for the same period are 0.7, -1.0, -1.1, 0.8 and 0.1. The reasons for the difference are explained in the earlier footnote. 14 Some speculate that there was also implicit political pressure from the meeting between the Finance Minister of Japan and the US Treasury secretary on September 4
The Board challenged the market expectation that non-sterilized intervention was to bepursued.Ittook a position thattheexchangeratewas oneof thevariablesto bemonitored, butmonetary policy should not particularly respond to the exchange rate movement,per se.5The Boardthen explained that non-sterilized intervention was not a useful concept for the central bank thatwatches total funds in the market, whatever various sources it came from.° In addition, the Boardstatement contained cautionary comments on the side effects of ZIRP, a forerunner to ending the ZIRPeleven months later.17The Board expressed displeasure on press reports and market reaction in strong words: “Inthe past few days, the market has substantially fluctuated by speculations on monetary policy. Whatshould be clear is that the conduct of monetary policy is exclusively decided by majority vote at theMonetaryPolicyMeeting,aregularmeetingof thePolicyBoard.Itisneverthecasethat ourpolicyisdetermined in advance or in consultation with outside bodies.We would liketo emphasize this point.(BankofJapan,"OntheCurrentMonetaryPolicy"September21,1999)The quotes from the statement vividly illustrated the position of the Board. Any reporting ofthe expected decision was considered to be a challenge to independence. The Board successfullyextinguished any expectation in the market that the Bank would be accommodative in response todesires from the government or the market. Any doubt about independence was erased on September21,1999.However, their own strong words might have trapped theBoard members:that is,theycould not change their positions in the following months.Between thefall of 1999 and the summer of2000, there was no additional easing,except forliquidity injections to deal with Y2K concerns. The government wanted some sort of additionalmeasures of monetary easing,while the Governor increasinglymentioned the possibility of liftingZIRP. At this point, the Bank explained that the Bank would continue ZIRP “"until deflationary15 "The foreign exchange rate in itself is not a direct objective of monetary policy. One of the preciouslessons we learned from the experience of policy operations during the bubble period is that, monetarypolicy operations linked with control of the foreign exchange rate runs a risk of leading to erroneous policydecisions. Having said this, it does not mean that monetary policy is pursued without any consideration tothedevelopmentoftheforeignexchangerate.TheBankconsidersitimportanttocarefullymonitorthedevelopment of theforeign exchangerate from theviewpoint of how itaffects the economyand prices."(Bank of Japan,"On theCurrent MonetaryPolicy"September21,1999)16"In relation to the foreign exchange rate policy,we have heard arguments in favor of non-sterilizedintervention. In the reserve market, however, there are various flows of funds such as currency incirculationandTreasuryfundsotherthanthoseresultingfromtheintervention.TheBankconductsitsdailymarketoperationstakingintoaccountallthemoneyflows,inordertocreateamplereservestosuchanextent as described above.This strong commitment of fund provision is consistent with the government'scurrentforeignexchangeratepolicy"(BankofJapan,"OntheCurrentMonetaryPolicy"September2l,1999)17The Bank views the current state of the Japanese economy as having stopped deteriorating with somebrightsigns,thoughaclearandsustainablerecoveryofprivatedemandhasyettobeseen.Inpursuingthezero interest rate policy,we need to carefully examine its adverse side-effects, but deem it important tosupport the economic recovery by continuing easy monetarypolicyfor the periods ahead." (Bank of Japan,"OntheCurrentMonetaryPolicy"September21,1999)13
13 The Board challenged the market expectation that non-sterilized intervention was to be pursued. It took a position that the exchange rate was one of the variables to be monitored, but monetary policy should not particularly respond to the exchange rate movement, per se. 15 The Board then explained that non-sterilized intervention was not a useful concept for the central bank that watches total funds in the market, whatever various sources it came from. 16 In addition, the Board statement contained cautionary comments on the side effects of ZIRP, a forerunner to ending the ZIRP eleven months later. 17 The Board expressed displeasure on press reports and market reaction in strong words: “In the past few days, the market has substantially fluctuated by speculations on monetary policy. What should be clear is that the conduct of monetary policy is exclusively decided by majority vote at the Monetary Policy Meeting, a regular meeting of the Policy Board. It is never the case that our policy is determined in advance or in consultation with outside bodies. We would like to emphasize this point.” (Bank of Japan, “On the Current Monetary Policy” September 21, 1999) The quotes from the statement vividly illustrated the position of the Board. Any reporting of the expected decision was considered to be a challenge to independence. The Board successfully extinguished any expectation in the market that the Bank would be accommodative in response to desires from the government or the market. Any doubt about independence was erased on September 21, 1999. However, their own strong words might have trapped the Board members: that is, they could not change their positions in the following months. Between the fall of 1999 and the summer of 2000, there was no additional easing, except for liquidity injections to deal with Y2K concerns. The government wanted some sort of additional measures of monetary easing, while the Governor increasingly mentioned the possibility of lifting ZIRP. At this point, the Bank explained that the Bank would continue ZIRP “until deflationary 15 “The foreign exchange rate in itself is not a direct objective of monetary policy. One of the precious lessons we learned from the experience of policy operations during the bubble period 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” September 21, 1999) 16 “In relation to the foreign exchange rate policy, we have heard arguments in favor of non-sterilized 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 government's current foreign exchange rate policy” (Bank of Japan, “On the Current Monetary Policy” September 21, 1999) 17 “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” September 21, 1999)
concerns subside". The economy started to show some sign of recovery in the spring of 2000.ICT-related stock prices went up and the Nikkei 225 increased by 30% between March 1999 andMarch 2000.Corporate profits rose and corporate investment showed signs of recovery.There wasan argument that these corporateearnings would trickle down tohouseholds to stimulate consumptionsooner or later.s This argument was dubbed the “dam theory": water was flling the corporate damand would overflow sooner or later.Governor Hayami, believing that this was communication withthe market, frequently suggested that there were bright signs in the economy and, as a consequence,there would be a possibility of raising the interest rate. Critics thought it was premature to talk aboutliftingthe interestrate,and anymention ofititselfdiminished theeffectof ZiRPbylimiting itseffectsthrough expectations that easing would continue into the future.The ZIRP was lifted in the Policy Board meeting of August 11, 2000.19At this point, thecontinuation of arecoveryof the Japanese economy was at bestdoubtful.First,theICT bubble hadended and stock prices in the United States and Japan were heading down, suggesting investment andconsumption would be adversely affected in the near future.Second, the US economy was beginningto show weakness, and Japanese exports to the United States were expected to decline in thefuture.Third, the inflation rate was still negative, and there was no sign of an end to deflation.Critics of theBank thought that ending ZIRP was a mistake.Indeed, the government exercised an option, specifiedin theBankof Japan Law,toputforward amotion for delaying voting of theproposal of raising theinterest rateuntil the next meeting.The government motion was overruled by theBoard byan 8 to1vote, and then the lifting of the zero interest ratepolicy was decided by a 7 to 2decision.Almost as soon as the interest rate was raised in August, the Japanese economy entered intoa recession.It was notknown at the time, but the official date for the peak of the business cycleturned outtobeOctober2000.Thegrowth rate of2000:1I turned negative,whichwas offsetto someextent by a brief recovery in 2000:IV.But, as the economy turned into a recession, the criticism ofthe Bank of Japan actionsbecame stronger.The economy weakened substantiallytoward the end of 2000. Many urged changes inmonetary policy.Some economists had recommended the return to ZiRP and others recommendedquantitative easing and unconventional monetary policy including increasing the amount of regularpurchases of long-term government bonds, and newly purchasing listed mutual funds of stocks.18 “Currently,it is our judgment that Japan's economy is at the stage where the number of firms taking theoffensivehasstartedincreasing,thatis,theeconomyismoderatelyrecoveringparallelwithstructuraladjustment....withrespecttotherecoveryofprivatedemand,itseemsnaturalthatthecorporatesectorwhichhasregainedprofitabilityasaresultofrestructuring,shouldtaketheleadbyincreasinginvestmentfollowedbythehousehold sectorasincomeconditionsgraduallyimprove.This isthedevelopmentweare nowwitnessing."(Speech given by Masaru Hayami, Governor of the Bank of Japan, at the JapanCenterforEconomicResearchonMay29,2000,http://www.boj.or.ip/en/press/00/ko0005b.htm#0103)19 Govemor Hayami intended to raise the interest rate in July.However,alargedepartmentstore,SOGOfailed and the economy showed some weakness.Theplan of lifting the interestrate was postponed withoutbeing submittedtothemeeting.14
14 concerns subside”. The economy started to show some sign of recovery in the spring of 2000, ICT-related stock prices went up and the Nikkei 225 increased by 30% between March 1999 and March 2000. Corporate profits rose and corporate investment showed signs of recovery. There was an argument that these corporate earnings would trickle down to households to stimulate consumption sooner or later. 18 This argument was dubbed the “dam theory”: water was filling the corporate dam and would overflow sooner or later. Governor Hayami, believing that this was communication with the market, frequently suggested that there were bright signs in the economy and, as a consequence, there would be a possibility of raising the interest rate. Critics thought it was premature to talk about lifting the interest rate, and any mention of it itself diminished the effect of ZIRP by limiting its effects through expectations that easing would continue into the future. The ZIRP was lifted in the Policy Board meeting of August 11, 2000. 19 At this point, the continuation of a recovery of the Japanese economy was at best doubtful. First, the ICT bubble had ended and stock prices in the United States and Japan were heading down, suggesting investment and consumption would be adversely affected in the near future. Second, the US economy was beginning to show weakness, and Japanese exports to the United States were expected to decline in the future. Third, the inflation rate was still negative, and there was no sign of an end to deflation. Critics of the Bank thought that ending ZIRP was a mistake. Indeed, the government exercised an option, specified in the Bank of Japan Law, to put forward a motion for delaying voting of the proposal of raising the interest rate until the next meeting. The government motion was overruled by the Board by an 8 to 1 vote, and then the lifting of the zero interest rate policy was decided by a 7 to 2 decision. Almost as soon as the interest rate was raised in August, the Japanese economy entered into a recession. It was not known at the time, but the official date for the peak of the business cycle turned out to be October 2000. The growth rate of 2000:III turned negative, which was offset to some extent by a brief recovery in 2000:IV. But, as the economy turned into a recession, the criticism of the Bank of Japan actions became stronger. The economy weakened substantially toward the end of 2000. Many urged changes in monetary policy. Some economists had recommended the return to ZIRP and others recommended quantitative easing and unconventional monetary policy including increasing the amount of regular purchases of long-term government bonds, and newly purchasing listed mutual funds of stocks, 18 “Currently, it is our judgment that Japan’s 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.” (Speech given by Masaru Hayami, Governor of the Bank of Japan, at the Japan Center for Economic Research on May 29, 2000, http://www.boj.or.jp/en/press/00/ko0005b.htm#0103 ) 19 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 of lifting the interest rate was postponed without being submitted to the meeting