Free Monetary Policy in Japan Essay Sample


The outbreak of the financial crisis in 2007 had produced a significant impact on the possibility of the Central Bank to monitor short-term interest rates in the interbank market, initially complicating this effect by reducing the transmission mechanism of monetary policy, and then, in a situation of liquidity trap by making such an impact impossible. In this situation, many the Japanese Central Bank has turned to unusual monetary policy actions. The forced nature of the transition to these measures was supplemented by the chaotic Japans Central Banks decision on the use of non-traditional interventions. It was due to lack of knowledge on the effects of unconventional monetary policy. This is due to the fact that it had not previously been considered generally applicable policy was not sufficiently theoretically studied. Hence, the monetary policy of any country is a set of particular measures which are aimed at sustaining and improving the national currency value and its impact and functioning within the national economic framework. Such factors as proper policy choice, tools of currency and GDP impact, economic environment of the country are accounted into the monetary decisions. During the 20th century the monetary policy of Japan has been changed several times. The most successful one was recorded during the 1960s and is currently referred to as the economic miracle. Therefore, the paper claims that the Japanese government is expected to perform the measures which are similar to the era of the economic miracle to return the leading status of the country on the world scale.

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Japanese Monetary Policy in 1960s

At the present stage of development of the world economy analysis of the problems of the evolution of monetary systems and their impact on economic growth is an important aspect in the study of national economies of the separate countries. Hence, in the course of the 1960-1970s, Japan showed the world the so-called economic miracle. In this regard, one of the factors of economic growth was relatively cheap labor. Average hourly wage of an industrial worker in Japan in the late 1960s, was seven times lower than in the US. The share of wage costs in total costs in Japan was three times less than in the US. However, on the other hand, in 1960, the nominal wages in Japan increased by in average up to 12.5% on the annual basis, while consumer prices advanced only by 5.9%, leading to an increase in real wages by 6.3% per year. It is not surprising that the Japanese maintained and developed the course.

During the period of 1960s, the impact of the monetary policy was that the rapid economic development was based and focused on the growing amount of consumer demand, which had a strong reverse effect on the sphere of production. This helped Japanese business quickly recoup their expenses and receive at the same high rate of return, which had been immediately sent to the productive accumulation. Another monetary impact of that time was the fact that the size of capital investment in Japan comparing to Britain, France and Germany was by 2.6 times higher in the 1960s. This enabled the country to speed up a massive upgrade of production facilities and go significantly ahead of major competitors.

The Japanese monetary policy in the 1960s is known to be the gold standard policy. Its aim was to bring the economic and currency situation of Japan to the highest level since it was much impacted by the after-WWII consequences. It included the governments decision and tools usage established by the Bretton Woods system to support the national currency. Those measures were impossible to be reached without the rapid activation of economy. Hence, the laws which were released to improve the monetary policy of Japan were closely connected with the economic situation in the country. This can be explained by the statement that it was largely influenced by the fact that after the war, the country had had no right to spend more than 10% of GDP on the needs of the military defense. Along with this, within the 1960 period of time, the broad masses of Japanese workers were involved in the process of rationalization of labor and production and in quality control of products to approach the highest standards of the gold standard monetary policy. Thus, enterprises in order to enhance the competitiveness of products and the prestige of the company had set up quality control circles, which were known to include representatives of management and trade unions in addition to the workers.

It is impossible not to note the features of the Japanese national character, which also affected the socio-economic development of the country. This is primarily due to the specifics of the Japanese culture and philosophy, ancient traditions: obedience, loyalty to the owner, the belief in the Japanese exceptionalism, etc. The very these traits had produced an incredible effect on the way the economy was developed and conducted.

By the middle of the 1960s, the situation in this area had changed dramatically, because foreign markets had already gained the vital importance. By that time, Japanese companies strengthened their products mainly has met the international standards, so they no longer needed the customs protection. The Japanese Government announced the liberalization of foreign economic relations. It became possible to create a specific model of foreign trade of Japan, according to which processing industry and imports began to prevail in the export of products of mineral raw materials and oil. During these years, Japan had actively increased its exports of cars, motorcycles, steel and metal products, ships, electronics, household electrical appliances. Thus, almost 46% of all manufactured electronics and 55% of its vehicles exported.

Japanese Monetary Policy in 1970s

The modern industrialization took place in Japan in two stages in the course of the 1970s. In the first phase (which had already started by the end of the 1960s), the main focus was on the development of material-intensive heavy industries: shipbuilding, oil refining and petrochemicals, ferrous and nonferrous metallurgy, etc.  At the same time, Japan went on the formation of new industries: plastics, electronics, synthetic rubber and chemical fibers instrumentation, etc. The very this approach caused the new monetary policy approach the price level targeting. The essential objective of this direction was to stabilize the prices for the essential raw materials and products produced in the country and, by this, to support the yen. This was determined by the fact that foreign patents and licenses, as a rule, were implemented in the manufacturing industry only after significant improvements and this aspect influenced the flow in prices. Hence, to stabilize the prices for the products, the Japanese government introduced the measures to reduce the inflation and impacted the control of the prices for the raw materials. However, as a consequence, the price level targeting impacted the Japans economic performance in the way that the production of consumer electronics, optical devices, color television sets, and video recorders had been rapidly increased. By the middle of the 1970s, Japan ranked second in the world in the number of embedded computers. It began production of automatic machines with numerical control, as well as the mass adoption in enterprises of different robotics.

The crucial event in the development of the Japanese economy was the energy crisis of the early 1970s, when the country had experienced the so-called oil shock. During the years 1974-1975, this caused a turndown in production in many industries and led to inflation. Different periods of time in Japan were accompanied by various relations between the actual inflation and the normal one (Fig. 1).

Figure 1. The Level of Inflation in Japan

This forced Japan to reconsider many of the economic priorities. The country which had not have its natural resources, was forced to urgently pass on material and energy-saving technologies, aggressively look for new sources of raw materials and fuel. It was also necessary to reduce the dependence on cyclical fluctuations inherent in the world economy.

Japanese Monetary Policy in 1980s

In conducting monetary policy during the 1980s, the Bank of Japan used traditional instruments. They comprised the foreign exchange intervention, the setting of official interest rate, purchase and sale of government securities, the definition of mandatory reserve requirements, etc. Prior to the beginning of the financial sector deregulation process, the most effective instrument of monetary regulation of the market was interest rate, as it was considered by the Bank of Japan. Today, their value has declined slightly.

In the time period of 1980s, keeping the yen was a priority aim this is why the fixed exchange rates monetary policy had been chosen as a main course. This indicator was directly related to the state of the economy. Its essential aim consisted in balancing the exchange rates which should have been reflected on the currency stability in Japan. The essential tool for the implementation of the policy was the following an agreement, which was reached in September 1985, according to which the government put an end to trade confrontation of Japan and the US. Hence, the value of the yen began to increase sharply. The impact of the newly chosen direction led to the fact that the government had to take measures to avoid deflation as a result of slowing economic growth. Hence, the Bank of Japan being impacted by the new monetary policy in the period from January 1986 to February 1987 had to cut interest rates five times, and brought it to 2.5%. This lowest level for the entire post-war history lasted for two years, although the cost of the yen continued to rise gradually.

The cost of the yen began to decline during the first months of 1989, and in May 1989 the Bank of Japan moved to the tight monetary policy. By the beginning of August 1990 it had raised the interest rates five times and brought them to 6%. By this, it contributed to higher interest rates in other Japanese banks, and the convergence of these rates with the interest rates in the United States. Undertaken measures by the Bank of Japans had slowed the outflow of capital in the United States. In 1980, Japan came to the forefront in the world in the production of medical equipment, communications equipment and satellite equipment, optical equipment, etc.

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Japanese Monetary Policy in 1990s

The rapid industrial breakthrough, undertaken by Japan in 1950-1980s, did not suffice to create a stable working economy that was expected to meet the 1990s modern requirements. The monetary model was formed at a relatively low level of consumption of the Japanese people in the name of the struggle for economic growth, and it could not make the transition to post-industrial stage of development of society. In the end of the 1980s and at the beginning of the 1990s, it became apparent that the artificially maintained development requires a continuous investment from the state to the economy. However, these investments could be obtained only by the scope of consumption. This fact required to conduct the mixed type monetary policy. Its aim was to provide the support and development of the various fields of monetary and economic field of the country. In this regard, it is appropriate to recall the so-called innate weaknesses, which were specific to Japan that time: the relative narrowness of the domestic market, the absence of its own raw material and energy base, the high degree of dependence on food imports, the poor quality of housing, the relative underdevelopment of the social infrastructure and poor social security of workers (pensions, all sorts benefits, health services), six-day working week and a very long time, a very short and paid annual leave, a huge population density in urban areas, etc. (Ueda 179a). All this has had an impact on the level and quality of life of the Japanese, but also confirms the idea that the Japanese economy has both strengths and weaknesses. the essential measures which have been introduced were similar to the ones which had been implemented during the previous decades, however, they were not very successful. This led to the situation in monetary policy which then was referred to as the lost decades.

Among the reasons that provoked the crisis in the monetary system of Japan of the 1990s, is the lack of its own base for the development of scientific and technical innovations and the resultant need for regular purchases of patents and licenses in the developed countries. That has played a positive role in the post-war breakout of the economy in 1980s 1990s and has become a brake on development. It turned out that the Japanese producers have nothing to offer in the field of information and scientific knowledge. Moreover, in other areas of the world market in Japan did not have competitive goods.

Japanese economists estimated that only about 10% of all Japanese products, especially advanced industries, corresponded to the world market standards. As for the industries, such ones as food, paper, cement, aluminum, pharmaceuticals, aviation, as well as agriculture and services, were far behind the Western Europe and the US. However, during the 1980s, the Japanese miracle was expressed not only in the rate of industrial growth, which in this period amounted to approximately 5-6% per year, but in the increase of prices in the stock market and real estate market. In 1989-1990, all major stock indexes, and the index of land prices have reached such high values ??that the giant pyramid investment could not long remain in a stable condition.

Due to the new direction in the monetary policy there were serious consequences. For instance, the serious problems have arisen in many banks, which have been associated with loans secured by real estate, land and securities. The budget revenues from the real economy were sharply reduced. In these circumstances, one of the ways out of the crisis was the increase in public debt. Herein, it is necessary to compare the following figures: in the beginning of the 1970s, its dimensions did not exceed 10% of GDP. However, 10 years later, they reached almost 40%, and by the first months of 1999, they composed almost 140% of GDP (Honda, Kuroki, and Tachibana 17). The total of the same bank loans to industrial companies in 1992 amounted to 262% of GDP (Fig. 1).

Fig. 1.

Hence, evaluating the lost decade, it is impossible to find those changes positive due to the low level of the economy development in the harsh market conditions.

Japanese Monetary Policy during the Two Recent Decades

To overcome the negative consequences of the monetary policy in Japan, the process of softening was first used in the Bank of Japan in 2006, under the government of Masakaru Hayami. The policy idea which was proposed by the Bank of Japan, was that the Central Bank should control the expansion of the monetary base and should encourage the increased consumption, creating a strong demand for goods and services, increasing jobs, contributing to economic recovery as a whole. Embodying the idea, in 2006, the Bank of Japan began to increase the purchase of long-term government bonds and announced its intention to carry out the operation of quantitative softening as long as the inflation rate stops decreasing.

The impact of the Japans monetary policy manifested in the fact that in March 2001, the Bank of Japan set the goal to expand the volume of bank reserves: up to 5 trillion yen and stimulated the implementation of the monetary aggregates monetary policy direction. As a consequence, by 2002, it had increased it by 30-35 trillion yen (equivalent to 6-7% of GDP), and this range is maintained for several years (Fig. 2). Formally, the stage of quantitative softening was completed by March 2006, and the Bank of Japan reiterated its request to the interest rate, as targets.

Fig. 2

The policy pursued by the Bank of Japan in 2006-2008 under the government of Toshihiko Fukui, was defined as bank reserves policy because it was aimed at increasing bank reserves at the Central Banks accounts. The instruments of this policy were a variety of techniques to mitigate the national reserve requirement, including the reduction of compulsory reserve requirements, the introduction of new rules of averaging provisions, expanding the list of exceptions allowed in the calculation of reserve requirements, and so on. The purpose of this policy was to increase the money supply in the economy. The resulting policy of the extra money is going to buy government bonds from financial institutions, and not to finance budget deficit and public debt, as often happens during the traditional policy of open market operations. Hence, the consequences and effects of conducting the monetary policy in deflationary environment are not negative, but, still, they are not extremely positive because the country is still in crisis.

To produce the separation from the old mitigation measures used by the Bank of Japan in 2001-2006, the new measures were aimed at lending a variety of financial institutions and providing liquidity to key credit markets. Forming a specific portfolio of loans and securities, the Central Bank affected successfully and positively the supply and demand in the financial market. Also, there was an impact on market interest rates, the assessment of banks riskiness of borrowers, thereby changing the conditions for granting credit to households and businesses, leading to stimulation of demand and economic growth. The country is currently still in crisis. Japanese society is experiencing a painful loss of the leading positions in the world economy, especially in the Asia-Pacific region. However, there are all prerequisites to Japan to retain its status as a full member of the community of the great powers in the 21st century. When evaluating the monetary policy of Japan in the recent decades, it becomes evident that the issue of demand is more prominent than the issue of supply. In fact the new methods of economy and monetary policies conduction are not negative to the extent that they are useless: oppositely, they should be more focused on the principles of the economic miracle to help the present policies obtain the necessary level of development of the country. The future prospects of the Japans monetary policy should cover such indexes as inflation, currency rates, GDP, banking sector etc. to ensure the proper functioning of the financial institutions of the country. Hence, to improve the situation and get rid of the woes, the Japanese government is expected to be directed to the course of economic miracle.


The main elements of the policy were the use of indicative plans of economic development. In the reform period as a whole, Japan held a successful monetary policy, providing the financial needs of the economy and at the same time keeping the inflation within reasonable limits. In the period of the 1960-1979, the average annual inflation growth in a percentage of the previous year amounted to 5.5% (in 1973, it was 11.6%, and in 1974, it was 23.2%). Monetary policy has become too soft in 1972 (the effects of the era of rapid growth) that led to the emergence of excess liquidity and worsened the inflation caused by the oil crisis in 1973. One of the main causes of excess liquidity was the policy of high public expenditures, pumped up the economy with money in connection with the implementation of an ambitious program of production redeployment (to alleviate the problem of overpopulation), and as a counterweight to the negative effects of liberalization and revaluation of the yen. Moreover, during the first half of the reform period (by the middle of the1960s), the monetary and interest rate policy had been the main instrument of rapid growth (because of the possibility of limiting the use of budget methods of the economy support for the adoption of maintaining balanced budgets commitments). Currently, Japanese government has to take extreme measures to find the way out of the crisis and lead the country to the highest positions on the world financial arena.


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