foreign bonds, and even real estate funds.These unconventional monetary tools had been rejected byBank of Japan economists earlier.As2001 started,manyindicators wereshowingweakness and theBank of Japan decidedtoease.The question then was whether to go back to the ZIRP or to introduce a new framework.quantitative easing.In February,the Bank introduced the so-called Lombard lending facility as well ascutting the official discount rate from 0.5% to 0.35%. The Lombard lending facility was to lendautomaticallyto banks with collateral at the official discount rate, so that the interestrate would becapped at 0.35%.However,themarket rate was at around 0.2-0.25%, so there was littlereal impactfrom the introduction of the Lombard facility.Pressure to ease monetary conditions did not stopbecause of thesemeasures inFebruary2001.The Policy Board meeting of March 19, 2001 turned out to be the beginning of quantitativeeasing as well as further easing in terms of the interestrate.The target inter-bank ratewas loweredimmediatelyto O.15 percent,and would go down to zero, as conditions warranted.The officialdiscount rate was cut to 0.25%. However, the policy change was not announced as just a return toZIRP.It was billed as a change in the monetary policy instrument.The instrument was changedfrom the short-term interest rate to the balance of current accounts at the Bank of Japan.The target ofthe current account was set at 5 trillion yen.However, by targeting an amount beyond requiredreserves (about 4 trillion yen),it effectively meant that the interbank rate (i.e., the call rate) would goto zero. This amounted to excess reserve targeting.20 In September 2001, the official discount rate wascut to 0.1 percent, but this did not have anyimpact.The Bank has also madeclearer the conditions when it would liftZIRP in thefuture.WhentheBank of JapanadoptedZIRPfor thefirsttime inFebruary1999,thecondition for liftingZIRP waswhen deflationary concerns were dispelled.When the ZIRP was effectively reintroduced in March2001, the condition became more concrete:Excess reserve targeting, or de facto ZIRP, would not beabandoned until the inflation rate,measured by CPI excludingfresh food,became stablyabovezeroThe exit condition would be further clarified in October 2003, to be explained later.From March 2001 to March 2003,quantitative easing was expanded in several steps.In August 2001, another measure of quantitative easing was employed.The amount of BOJ?outrightpurchasesof long-termgovernmentbondswasraisedfrom400billionyenpermonthto600 billion yen per month.At the same time, the current account target was raised to 6 trillionyen (or about 2 trillion yen excess reserves).InDecember2001,themonthlypurchaseoflong-termbondswasincreasedfrom600billionyen20 Earlier than it was adopted in March 2001,BOJ economist, Mr.Okina (1999) reviewed the excessreservetargetingasapossibilityofnextstepoffurthermonetaryeasing.Hepointedoutafewproblemswith this option.First,"what kind offunction can beexpected ofexcessreserves"is notknown withcertainty and it was identified as a problem. Second, excess reserves is not reliable"as an indicator formonetary easing."Third, Dr.Okina points out an operational hurdle.15
15 foreign bonds, and even real estate funds. These unconventional monetary tools had been rejected by Bank of Japan economists earlier. As 2001 started, many indicators were showing weakness and the Bank of Japan decided to ease. The question then was whether to go back to the ZIRP or to introduce a new framework, quantitative easing. In February, the Bank introduced the so-called Lombard lending facility as well as cutting the official discount rate from 0.5% to 0.35%. The Lombard lending facility was to lend automatically to banks with collateral at the official discount rate, so that the interest rate would be capped at 0.35%. However, the market rate was at around 0.2 – 0.25%, so there was little real impact from the introduction of the Lombard facility. Pressure to ease monetary conditions did not stop because of these measures in February 2001. The Policy Board meeting of March 19, 2001 turned out to be the beginning of quantitative easing as well as further easing in terms of the interest rate. The target inter-bank rate was lowered immediately to 0.15 percent, and would go down to zero, as conditions warranted. The official discount rate was cut to 0.25%. However, the policy change was not announced as just a return to ZIRP. It was billed as a change in the monetary policy instrument. The instrument was changed from the short-term interest rate to the balance of current accounts at the Bank of Japan. The target of the current account was set at 5 trillion yen. However, by targeting an amount beyond required reserves (about 4 trillion yen), it effectively meant that the interbank rate (i.e., the call rate) would go to zero. This amounted to excess reserve targeting. 20 In September 2001, the official discount rate was cut to 0.1 percent, but this did not have any impact. The Bank has also made clearer the conditions when it would lift ZIRP in the future. When the Bank of Japan adopted ZIRP for the first time in February 1999, the condition for lifting ZIRP was when deflationary concerns were dispelled. When the ZIRP was effectively reintroduced in March 2001, the condition became more concrete: Excess reserve targeting, or de facto ZIRP, would not be abandoned until the inflation rate, measured by CPI excluding fresh food, became stably above zero. The exit condition would be further clarified in October 2003, to be explained later. From March 2001 to March 2003, quantitative easing was expanded in several steps. In August 2001, another measure of quantitative easing was employed. The amount of BOJ outright purchases of long-term government bonds was raised from 400 billion yen per month to 600 billion yen per month. At the same time, the current account target was raised to 6 trillion yen (or about 2 trillion yen excess reserves). In December 2001, the monthly purchase of long-term bonds was increased from 600 billion yen 20 Earlier than it was adopted in March 2001, BOJ economist, Mr. Okina (1999) reviewed the excess reserve targeting as a possibility of next step of further monetary easing. He pointed out a few problems with this option. First, “what kind of function can be expected of excess reserves” is not known with certainty and it was identified as a problem. Second, excess reserves is not reliable “as an indicator for monetary easing.” Third, Dr. Okina points out an operational hurdle
to 800 billion yen, the current account target was raised to 10-15 trillion yen.InFebruary2002,the monthlypurchase of long-term bonds was increasedfrom 800 billion yen to福1trillionyen?In October 2002, the monthly purchase of long-term bonds was raised to 1.2 trillion yen from 800billion yen, and the current account target was raised to 15-20 trillion yen.There have been mixed reviews on these steps.Although these steps expanded quantitativeeasing,especially in the amount of long-term bonds from 400 billion yen per month in September2001 to 1.2 trillion yen per month in October 2002, deflation worsened.Some argue that this showsthat quantitative easing did not work.However,advocates ofquantitative easing would say that theseactions prevented a majordecline in economic activitiesThese measures are summarized in the Figure 3.The top chart shows the expansion ofpurchase of long-term bonds and current account target, while the bottom chart shows themovementsof the official discount rateand the call rate.InsertFigure3about here3.2.Assessmentof theHayamiRegimeIn the initial stage (April 1998 to March 1999) of the Hayami regime, until ZIRP was adopted, manyBank of Japan officials expressed a negative view toward further easing (zero interest rate andquantitative easing including base money expansion,government bond and equity purchases),indicating that it was either ineffective or would have undesirable side effects, including the risk ofhigh inflation.21 The call for easing by scholars was being rebuffed. (See Krugman (1998), Meltzer(1998), McKinnon and Ohno (1997) for the calls for monetary easing: and Okina (1999a, b) for the21One such cautious opinion was expressed in July1999byKazuoUeda,aformerUniversity of Tokyoprofessor,anewlyappointedPolicyBoardmember."Thepolicytoincreasethemoneysupplywouldfirstcreate some decline in the call rate, but automatically create further rate declines if the economy worsensand the demand for money declines. In this sense the commitment to avoid deflationary forces is strongerwith money supply targeting. ...To the extent that the money supply works through interest rates, thecommitment money supply targeting delivers is already contained in the current policy stance. ...Theargument that an increase in the growth rate of the money supply increases inflationary expectations andstimulates aggregate demand by lowering real interest rates sounds attractive. It is unclear again,however.howthismechanismworkswhenthenominal interestratehasbeenalreadydrivendowntozero....Howaboutapolicyoflettingthemonetarybasegrowat20or30%then?Inflationdoesnotseemtobeonthehorizon. One can tighten after the inflation rate reaches 1 or 2%.We think such a policy would have a smallchance of success for reasons already mentioned. When it does succeed, it will probably generate a muchhigher rate ofinflation than1or 2%.Because of lags in the effects of policy,the 20-30%moneygrowth willcontinue to generate inflationary pressure even after the tightening starts."(Kazuo Ueda, Member of thePolicyBoard of theBank of Japan,at theMeeting on Economic and Financial Matters inKagoshima, onJuly1,1999,http://www.boj.or.ip/en/press/99/ko9907a.htm)16
16 to 800 billion yen, the current account target was raised to 10-15 trillion yen. In February 2002, the monthly purchase of long-term bonds was increased from 800 billion yen to 1 trillion yen. In October 2002, the monthly purchase of long-term bonds was raised to 1.2 trillion yen from 800 billion yen, and the current account target was raised to 15-20 trillion yen. There have been mixed reviews on these steps. Although these steps expanded quantitative easing, especially in the amount of long-term bonds from 400 billion yen per month in September 2001 to 1.2 trillion yen per month in October 2002, deflation worsened. Some argue that this shows that quantitative easing did not work. However, advocates of quantitative easing would say that these actions prevented a major decline in economic activities. These measures are summarized in the Figure 3. The top chart shows the expansion of purchase of long-term bonds and current account target, while the bottom chart shows the movements of the official discount rate and the call rate. Insert Figure 3 about here 3.2. Assessment of the Hayami Regime In the initial stage (April 1998 to March 1999) of the Hayami regime, until ZIRP was adopted, many Bank of Japan officials expressed a negative view toward further easing (zero interest rate and quantitative easing including base money expansion, government bond and equity purchases), indicating that it was either ineffective or would have undesirable side effects, including the risk of high inflation. 21 The call for easing by scholars was being rebuffed. (See Krugman (1998), Meltzer (1998), McKinnon and Ohno (1997) for the calls for monetary easing; and Okina (1999a, b) for the 21 One such cautious opinion was expressed in July 1999 by Kazuo Ueda, a former University of Tokyo professor, a newly appointed Policy Board member. “The policy to increase the money supply would first create some decline in the call rate, but automatically create further rate declines if the economy worsens and the demand for money declines. In this sense the commitment to avoid deflationary forces is stronger with money supply targeting. .To the extent that the money supply works through interest rates, the commitment money supply targeting delivers is already contained in the current policy stance. .The argument that an increase in the growth rate of the money supply increases inflationary expectations and stimulates aggregate demand by lowering real interest rates sounds attractive. It is unclear again, however, how this mechanism works when the nominal interest rate has been already driven down to zero. .How about a policy of letting the monetary base grow at 20 or 30% then? Inflation does not seem to be on the horizon. One can tighten after the inflation rate reaches 1 or 2%. We think such a policy would have a small chance of success for reasons already mentioned. When it does succeed, it will probably generate a much higher rate of inflation than 1 or 2%. Because of lags in the effects of policy, the 20-30% money growth will continue to generate inflationary pressure even after the tightening starts.” (Kazuo Ueda, Member of the Policy Board of the Bank of Japan, at the Meeting on Economic and Financial Matters in Kagoshima, on July 1, 1999, http://www.boj.or.jp/en/press/99/ko9907a.htm )
rebuff.)When ZIRPwas adopted in the spring of 1999, the Bank maintained the view that no furthersteps were needed. The Bank strongly resented any pressure or even suggestion from outside onfurther easing,as shown in the episode of their complaining about the speculation of easing before theMeeting in September 19999. In the spring of 2000, Governor Hayami started to suggest endingZIRP.Most likely,he wanted to communicate with the market on the Bank's future intentions, inorder to avoid a “surprise" reaction of the market and resulting volatility in the money and capitalmarket.However,this suggestion certainly diminished any beneficial effects of ZiRPbecause itcreated expectations of higher interest rates in the future.The interest rate was raised in August 2000despite the opinions by many scholars and the government of the need for further easing.In aninternational conference sponsored by the Bank of Japan in July2000,many scholars and foreignparticipants were critical of thepast and currentpolicy of the Bank of Japan:Meltzer (2001),Goodfriend (2001), Svensson (2001) (note the publication date of these papers was in 2001, but theconferencetookplace in July2000, onemonth beforetheZIRPwas reversed).Oda andOkina (2001)compare various policy options of monetary easing and their associated risks. The authors emphasizedmore therisks than benefits of policy options proposed to theBank of Japan by"academics".Theyargued that “introduction of a temporary fixed exchange rate system and a huge increase in theoutright purchase of medium- and long-term government bonds can induce relatively large effects,although the uncertainty in the effects as well as the accompanied costs and risks may be verylarge."One of the discussants, Jack Beebe (2001),felt that the“authors'views ofpolicyfeasibility and risksare unduly pessimistic. ...Thus, the risks inherent in taking further policy actions need to be balancedagainst the risks of not taking them."What is striking is that the conference at which this debate tookplace occurred one month before the interest-rate hike when ZiRP was exited, which we view was aclearpolicymistake.When the ZIRP returned with quantitative easing (current account balance of 5 trillion yenimplying the excess reserve of 1 trillion yen) in March 2001, the Bank did not explain why the changein policy would be effective, and this was particularly important because the Bank had not beenpositive on its effectiveness in the past.In the summer to fall of 2001, there were calls for furthereasing by raising the current accounttarget increase,increasing bond purchases, and purchasingequities and foreign bonds.Bank economists were negative on these suggested actions, saying that itwas impossible to raise the current balance target (no buyers of short term paper with zero interestrates),ornoeffect beyond stabilizing thefinancial system, and that risk ofpossibledeterioration ofbalance sheets would be serious.22 The policy started to change in December 2001, when the current22 Three options for further monetary easing can be considered when moneymarket interest rates are nearzero. ... Third, the BOJ can carry out unconventional operations by purchasing assets other than short-termJapanese government securities....The third policy option is for a central bank to purchase non-traditionalassetssuchasgovernmentbonds,foreigncurrencies,corporatebonds,stocks,orrealestatewhicharemoreimperfectly substitutablefor base money than are short-term government securities.As stated above,central bankoperations that amountto theexchange of perfect substitutes produce little effect on the17
17 rebuff.) When ZIRP was adopted in the spring of 1999, the Bank maintained the view that no further steps were needed. The Bank strongly resented any pressure or even suggestion from outside on further easing, as shown in the episode of their complaining about the speculation of easing before the Meeting in September 19999. In the spring of 2000, Governor Hayami started to suggest ending ZIRP. Most likely, he wanted to communicate with the market on the Bank’s future intentions, in order to avoid a “surprise” reaction of the market and resulting volatility in the money and capital market. However, this suggestion certainly diminished any beneficial effects of ZIRP because it created expectations of higher interest rates in the future. The interest rate was raised in August 2000 despite the opinions by many scholars and the government of the need for further easing. In an international conference sponsored by the Bank of Japan in July 2000, many scholars and foreign participants were critical of the past and current policy of the Bank of Japan: Meltzer (2001), Goodfriend (2001), Svensson (2001) (note the publication date of these papers was in 2001, but the conference took place in July 2000, one month before the ZIRP was reversed). Oda and Okina (2001) compare various policy options of monetary easing and their associated risks. The authors emphasized more the risks than benefits of policy options proposed to the Bank of Japan by “academics”. They argued that “introduction of a temporary fixed exchange rate system and a huge increase in the outright purchase of medium- and long-term government bonds can induce relatively large effects, although the uncertainty in the effects as well as the accompanied costs and risks may be very large.” One of the discussants, Jack Beebe (2001), felt that the “authors’ views of policy feasibility and risks are unduly pessimistic. . Thus, the risks inherent in taking further policy actions need to be balanced against the risks of not taking them.” What is striking is that the conference at which this debate took place occurred one month before the interest-rate hike when ZIRP was exited, which we view was a clear policy mistake. When the ZIRP returned with quantitative easing (current account balance of 5 trillion yen implying the excess reserve of 1 trillion yen) in March 2001, the Bank did not explain why the change in policy would be effective, and this was particularly important because the Bank had not been positive on its effectiveness in the past. In the summer to fall of 2001, there were calls for further easing by raising the current account target increase, increasing bond purchases, and purchasing equities and foreign bonds. Bank economists were negative on these suggested actions, saying that it was impossible to raise the current balance target (no buyers of short term paper with zero interest rates), or no effect beyond stabilizing the financial system, and that risk of possible deterioration of balance sheets would be serious. 22 The policy started to change in December 2001, when the current 22 “Three options for further monetary easing can be considered when money market interest rates are near zero. .Third, the BOJ can carry out unconventional operations by purchasing assets other than short-term Japanese government securities. .The third policy option is for a central bank to purchase non-traditional assets such as government bonds, foreign currencies, corporate bonds, stocks, or real estate which are more imperfectly substitutable for base money than are short-term government securities. As stated above, central bank operations that amount to the exchange of perfect substitutes produce little effect on the
account target was raised and long-bond purchases were raised in several steps. What was brandedimpossiblewas nowpossible,and the concern aboutthebalancesheet,emphasized earlierbythe Bankitself, was buried without addressing it formally.In September 2002, the Bank started to purchase equities that the commercial banks held butwanted to dispose of in light of declining stock prices.Earlier, the Bank had denied any possibility ofpurchasing stocks.23 The action was justified by the Bank on the ground that it would reduce the riskof commercial banks'balance sheets,and it was made clear that it was not intended as monetary policy.but rather as financial market stabilization policy.(The decision was not made by the Monetary PolicyBoard Meeting -equivalent of FOMC-but the regular Board Meeting.) However, it was notexplained why the resulting risk to the BOJ balance sheet due to financial stabilization policy was nota big concern, while it was for monetary policy.In October2000,theBankpaper“OnPriceStability"emphasized that itwouldbedifficultto focus on a particular price index as a guide to policy.Earlier, the Bank was quite negative on theidea of inflation targeting. However, in March 2001, the Board decided to adopt the ZIRP plusquantitativeeasinguntil the CPI excludingfreshfood showed apositive inflationratestably abovezero."This seemed to be a welcome switch from negative to a positive attitude toward selecting aprice index and targeting a numerical number, but the switch was not explained. In sum, the Bank hasbeen changing its position and action,but the switch was not explained well, and contributed to thedecline in the credibility of the bank.3.3.FukuiRegimeThe new Governor Toshihiko Fukui took over the leadership of the Bank of Japan at thematurity of the five year term of Governor Hayami in March 2003.Two deputy governors were alsoreplaced.One of the two newDeputy Governors is Mr.Toshiro Muto who was earlierVice Minister ofFinance;and the otherDr.Kazumasa Iwata,a former professor of economics.Dr.Iwata hasbeeneconomy. Such non-traditional operations are effective because they directlyalter the prices of the assets inquestion.Possiblebenefitsandcostsofthismonetarypolicyoption,howeverareextremelyuncertain.(Kazuo Ueda, Member of the Policy Board,at the semi-annual meeting of the Japan Societyof MonetaryEconomics held at Fukushima University in Fukushima City on September 29,2001,http:/www.boj.or.jp/en/press/01/ko0112a.htm#0301)23GovemorHayamidenied thepossibilityofpurchasing stocksas earlyas1998,and repeatedlyopposedto this saying that it violates the law."There is intrinsically a very strict limit as to the extent to which acentral bank can take on private sector risk.By shouldering such risk and seeing a subsequentdeterioration in our assets, we might lose the confidence placed in us to fulfill our fundamental mission.Hence, the new Bank of Japan Law (effective April 1998) prohibits the Bank from purchasing equitiesbearing large credit and price risks. We thus do not think it appropriate to purchase corporate debt andequity.(AsummaryofthespeechgivenbyMasaruHayamiGovernor,theBankofJapantotheKisaragi-kaimeetinginTokyoonDecember22,1998)_http://www.boj.or.jp/en/press/98/ko9812a.htmThe switch infall of 2002,whyGovernor changed the opinion and thepurchasebecame possible withoutchanging the law, was notexplained.18
18 account target was raised and long-bond purchases were raised in several steps. What was branded impossible was now possible, and the concern about the balance sheet, emphasized earlier by the Bank itself, was buried without addressing it formally. In September 2002, the Bank started to purchase equitiesthat the commercial banks held but wanted to dispose of in light of declining stock prices. Earlier, the Bank had denied any possibility of purchasing stocks. 23 The action was justified by the Bank on the ground that it would reduce the risk of commercial banks’ balance sheets, and it was made clear that it was not intended as monetary policy, but rather as financial market stabilization policy. (The decision was not made by the Monetary Policy Board Meeting –equivalent of FOMC—but the regular Board Meeting.) However, it was not explained why the resulting risk to the BOJ balance sheet due to financial stabilization policy was not a big concern, while it was for monetary policy. In October 2000, the Bank paper “On Price Stability” emphasized that it would be difficult to focus on a particular price index as a guide to policy. Earlier, the Bank was quite negative on the idea of inflation targeting. However, in March 2001, the Board decided to adopt the ZIRP plus quantitative easing until the CPI excluding fresh food showed a positive inflation rate “stably above zero.” This seemed to be a welcome switch from negative to a positive attitude toward selecting a price index and targeting a numerical number, but the switch was not explained. In sum, the Bank has been changing its position and action, but the switch was not explained well, and contributed to the decline in the credibility of the bank. 3.3. Fukui Regime The new Governor Toshihiko Fukui took over the leadership of the Bank of Japan at the maturity of the five year term of Governor Hayami in March 2003. Two deputy governors were also replaced. One of the two new Deputy Governorsis Mr. Toshiro Muto who was earlier Vice Minister of Finance; and the other Dr. Kazumasa Iwata, a former professor of economics. Dr. Iwata has been economy. Such non-traditional operations are effective because they directly alter the prices of the assets in question. Possible benefits and costs of this monetary policy option, however, are extremely uncertain.” (Kazuo Ueda, Member of the Policy Board, at the semi-annual meeting of the Japan Society of Monetary Economics held at Fukushima University in Fukushima City on September 29, 2001, http://www.boj.or.jp/en/press/01/ko0112a.htm#0301 ) 23 Governor Hayami denied the possibility of purchasing stocks as early as 1998, and repeatedly opposed to this saying that it violates the law. “There is intrinsically a very strict limit as to the extent to which a central bank can take on private sector risk. By shouldering such risk and seeing a subsequent deterioration in our assets, we might lose the confidence placed in us to fulfill our fundamental mission. Hence, the new Bank of Japan Law (effective April 1998) prohibits the Bank from purchasing equities bearing large credit and price risks. We thus do not think it appropriate to purchase corporate debt and equity. (A summary of the speech given by Masaru Hayami Governor, the Bank of Japan to the Kisaragi-kai meeting in Tokyo on December 22, 1998) http://www.boj.or.jp/en/press/98/ko9812a.htm. The switch in fall of 2002, why Governor changed the opinion and the purchase became possible without changing the law, was not explained
known tofavor inflation targetingThe newteam movedquicklyto increase thecurrent accountbalance attheBank of Japan.The target amount was raised from 15-20 trillion yen,at the time of March 2003 to 30-35 trillion yenas of January 2004.The amount of long-term bond purchases was not changed.The biggest change has been the rhetoric.Governor Fukui has made it explicit that the Bankshould maintain ZIRP until the inflation rate was clearly above zero.He seems to indicatecommitmentofZiRPintothefuture,a sortofcommitmentrecommended by inflation targetadvocates,oreven better.24Although the new policy is a big improvement over the lastregime, there was some roomforimprovement.The toleranceofinflation was not indicated with precise numbers.Therefore,it was lesscrediblethan otherwise.One answer to such a criticism is the policy announcement of October 2003.Itlaid out the conditions for raising the interest rate:"First, it requires not only that the most recently published core CPI should register a zeropercent or above, but also that such tendency should be confirmed over a few months.Second, the Bank needs to be convinced thatthe prospectivecore CPI will not be expected toregister below a zero percent. This point will be described in such materials as the analysis andthe forecasts of Policy Board members in the Outlook Report. To be more specific, many PolicyBoard members need to make the forecasts that the core CPI will register above a zero percentduring the forecasting period.The above conditions are the necessary condition.There may be cases, however, that the Bankwill judge it appropriate to continue with quantitative easing even if these two conditions arefulfilled." (Bank of Japan, Monetary Policy Committee announcement, October 13, 2003)Despite the good performance in the GDP growth rate in 2003:IV,the financial and capital marketparticipants expect that ZIRP will continue for a long time. This is a big change from the Hayamiregime.Sofar,credibilityof theBank of Japan tomaintainZIRP seems tobeontherise.The recent history of Japanese monetary policy has created two basic problems for theJapanese monetary authorities today.First,the Bank of Japan's policies have left Japan in aprolonged deflationary environment in which conventional monetary policy through lowering theshort-terminterest rate is no longer effective because thepolicyratehas hit afloor of zero.Second,24 In his speech to economists, Fukui (2003)tried to put a spin that theexit-from-ZIRP condition that theBank had adopted was more tolerant to inflation than a usual inflation target: "Assuming that a target hasbeen established (for example, at 2 percent), if the expected inflation rate rises above the target and theBank does not start tightening at that early stage, the actual inflation rate is likely to go beyond the target.Since the Bank's current policy commitments do not assume such a tightening at an early stage,theyactually run a risk in the direction of greater inflation than in the case of standard inflation targeting"19
19 known to favor inflation targeting. The new team moved quickly to increase the current account balance at the Bank of Japan. The target amount was raised from 15-20 trillion yen, at the time of March 2003 to 30-35 trillion yen as of January 2004. The amount of long-term bond purchases was not changed. The biggest change has been the rhetoric. Governor Fukui has made it explicit that the Bank should maintain ZIRP until the inflation rate was clearly above zero. He seems to indicate commitment of ZIRP into the future, a sort of commitment recommended by inflation target advocates, or even better. 24 Although the new policy is a big improvement over the last regime, there was some room for improvement. The tolerance of inflation was not indicated with precise numbers. Therefore, it was less credible than otherwise. One answer to such a criticism is the policy announcement of October 2003. It laid out the conditions for raising the interest rate: “First, it requires not only that the most recently published core CPI should register a zero percent or above, but also that such tendency should be confirmed over a few months. Second, the Bank needs to be convinced that the prospective core CPI will not be expected to register below a zero percent. This point will be described in such materials as the analysis and the forecasts of Policy Board members in the Outlook Report. To be more specific, many Policy Board members need to make the forecasts that the core CPI will register above a zero percent during the forecasting period. The above conditions are the necessary condition. There may be cases, however, that the Bank will judge it appropriate to continue with quantitative easing even if these two conditions are fulfilled.” (Bank of Japan, Monetary Policy Committee announcement, October 13, 2003) Despite the good performance in the GDP growth rate in 2003:IV, the financial and capital market participants expect that ZIRP will continue for a long time. This is a big change from the Hayami regime. So far, credibility of the Bank of Japan to maintain ZIRP seems to be on the rise. The recent history of Japanese monetary policy has created two basic problems for the Japanese monetary authorities today. First, the Bank of Japan’s policies have left Japan in a prolonged deflationary environment in which conventional monetary policy through lowering the short-term interest rate is no longer effective because the policy rate has hit a floor of zero. Second, 24 In his speech to economists, Fukui (2003) tried to put a spin that the exit-from-ZIRP condition that the Bank had adopted was more tolerant to inflation than a usual inflation target: “Assuming that a target has been established (for example, at 2 percent), if the expected inflation rate rises above the target and the Bank does not start tightening at that early stage, the actual inflation rate is likely to go beyond the target. Since the Bank’s current policy commitments do not assume such a tightening at an early stage, they actually run a risk in the direction of greater inflation than in the case of standard inflation targeting