Bank of Japan
From FXPedia
The Bank of Japan (“The Bank”) is Japan's central bank and is instrumental in setting monetary policy in Japan.
History[1]
The Bank of Japan was established in 1882 as the nation's central bank under the Bank of Japan Act. It was reorganized during wartime ("The Act of 1942") so that "the general economic activities of the nation might adequately be enhanced." The Act of 1942 was amended several times after World War II, including a change in 1949 to establish the Policy Board as the Bank's highest decision-making body.
The Act of 1942 was revised completely in June 1997 under the two principles of independence and transparency. The revised act came into effect on April 1, 1998.
Mandate[2]
The Bank of Japan Act (1997) sets the Bank's objectives "to issue banknotes and to carry out currency and monetary control" and "to ensure smooth settlement of funds among banks and other financial institutions, thereby contributing to the maintenance of stability of the financial system."
The Act also stipulates that "currency and monetary control by the Bank of Japan shall be aimed at achieving price stability, thereby contributing to the sound development of the national economy." Price stability (an economic environment with neither inflation nor deflation) is considered the prime mandate, and has occupied the Bank’s attention since its 1997 reorganization. There is no mention in the Act of other economic objectives such as aggregate demand or full employment. [3]
Activities
According to the Bank of Japan website, the Bank engages in the following activities to maintain its mission of maintaining price stability and financial system stability.
Issuing Banknotes and Coins
As the nation's sole "issuing bank," the Bank of Japan uses a number of measures to discourage counterfeiting, and ensures that worn and soiled banknotes are destroyed.
Buying and Selling Monetary Policy Instruments to Conduct Monetary Policy
The Bank aims for price stability, and to that end it uses day-to-day money market operations to control the overall volume of money in the economy. These operations include the sale or purchase of money market instruments such as Japanese Government Securities (JGSs) to and from private financial institutions.
To maintain price stability in times of weak economic activity and deflation, the Bank buys money market instruments from or lends money to financial institutions to increase the volume of money in the economy and keep interest rates low. In periods when economic activity is too strong, it sells them back to or accepts deposits from financial institutions to reduce the money supply. During money market operations, the Bank accepts repo transactions with different maturities (from one day up to one year). In a repo transaction, financial institutions borrow funds from the Bank and provide Japan Government Securities as the collateral. On the day of maturity, the Bank of Japan returns these securities and receives the principal plus interest (the “JGS repo rate”).
For more information the recent monetary policy decisions, see the section below.
Providing Settlement Services and Ensuring the Stability of the Financial System
The Bank of Japan acts as the "bank's bank" to ensure the stability of the financial system:
- It settles financial transactions by transferring funds between financial institutions. It transfers over JPY300 trillion per day via its electronic settlement system, the Bank of Japan Financial Network System (BOJ-NET).
- It monitors the financial and management conditions of financial institutions, with regular on-site reviews and close tracking of trends in loans and deposits.
- It functions as lender of last for insolvent financial institutions that might pose a threat to the financial system.
Treasury and Government Securities-Related Operations
The Bank of Japan acts as the "government's bank," handling receipts and disbursements of treasury funds, including acceptance of tax monies and payment of public works expenditures and public pensions. It also conducts accounting and bookkeeping for government agencies. In addition, the Bank handles the issuance, registration, interest payment, and redemption of Japanese government securities, using BOJ-NET for settlement. International Transactions and Cooperation The Bank of Japan assists the international financial community in the following ways:
- Transactions and Operations: The Bank provides yen accounts to other central banks and overseas government institutions, and provides capital subscriptions and loan extensions to international organizations such as the Bank for International Settlement (BIS) and the International Monetary Fund (IMF).
- Foreign Exchange Intervention: The Bank intervenes when necessary in foreign exchange markets as an agent of the Minister of Finance.
- International Cooperation: The Bank attends international forums such as BIS, the Group of 7, and the IMF to strengthen cooperation with other central banks.
Data Compilation, Economic Analysis and Research
The Bank tracks Japan's financial and economic conditions by collecting and analyzing various economic and financial statistics (from Bank branches, government agencies, corporations, opinion polls, and other sources). It publishes statistics such as the Corporate Goods Price Index and the Corporate Service Price Index. The Bank also conducts theoretical research from a longer-term perspective on issues such as monetary policy and the financial system.
The Bank releases a quarterly business survey known as the Tankan (a short form for a Japanese expression meaning “Short-Term Economic Survey”). The Tankan report is a summary of the Bank’s replies to questions submitted by around ten thousand private corporations, and is one of the most watched economic surveys in Japan. The Bank also publishes a monthly opinion survey, the Recent Economic and Financial Developments Report (the Teiki).
Accountability and Governance [4]
Policy Board
The Policy Board is the Bank's highest decision-making body. It determines the guidelines for currency and monetary control, sets the basic principles for carrying out the Bank's operations, and oversees the fulfillment of the duties of Bank executives.
Monetary policy guidelines include the following: money market operation guidelines; the official discount rate; reserve requirements ratios; the Bank’s view of economic and financial developments; and the types, terms, and conditions of bills and bonds used in money market operations. [5]
The Policy Board includes the Governor and Deputy Governors, and six other Board members. It conducts regular meetings, with published minutes, where it decides matters relating to monetary policy.
Executives
The Bank has the following executive posts: the Governor (one), the Deputy Governors (two), the other members of the Policy Board (six), Auditors (three or less), Executive Directors (six or less), and Counsellors (a few).
Executive Directors assist the Governor and the Deputy Governors on how the Bank should conduct its business, and are appointed by the Minister of Finance for four years on the recommendation of the Policy Board. Counsellors help the Policy Board on various subjects, and are appointed by the Minister of Finance on the recommendation of the Policy Board for two years. The current Bank Governor (the 30th) is Mr. Masaaki Shirakawa. He became Governor on April 9, 2008, and his 5-year term will end 2013.
Bank Independence
The Bank of Japan Act (1997) enshrines the principle of independence, although Article 4 of the Act implies that cooperation with the government is expected:
In recognition of the fact that currency and monetary control is a component of overall economic policy, the Bank of Japan shall always maintain close contact with the government and exchange views sufficiently, so that its currency and monetary control and the basic stance of the government's economic policy shall be mutually harmonious. [6]
To ensure the Bank’s independence, the Governor of the Bank of Japan cannot be removed by the Government from a five-year term, unless determined by the House of Representatives to be physically or mentally incapacitated. Government officials attend Board meetings only as non-voting members [7]
Bank actions since 1997 indicate that the Bank has become a mature, independent Central Bank. For example, the Bank overruled government officials in August, 2000 when it opted to raise the call rate from 0% to 0.25%. [8]
Locations
The Bank has 32 branches and 14 local offices in Japan, and seven overseas representative offices. There are 15 departments at the Bank's Head Office. For details, go to the Bank of Japan site.
Capitalization
In accordance with the Bank of Japan Act, the Bank is capitalized at 100 million yen, with the government contributing no less than fifty-five million yen.
Recent Monetary Policy
The Growing Importance of Money Market Operations, 1945-1996 [9]
In the post-war period, the Bank maintained stable money supplies and interest rates by raising or lowering the lending rates for funds it loaned to financial institutions. The Bank introduced upper limits on these loans in 1962 (to alleviate an increasing dependence on these loans) and in the same year introduced a policy where the additional funds required by rapid economic expansion at the time would be supplied not through loans but through operations involving government bonds.
As Japan’s economic growth stabilized and its financial markets matured, the Bank introduced a variety of new types of money market operations designed to control the money supply by infusing money into the economy during deflationary times and removing money during inflationary times. By controlling the money supply in this way, the Bank could by extension influence interest rates and create price stability.
Examples of enhanced money market operations included:
- The introduction of bill purchase and sale operations (early 1970s)
- The purchase and sale under repurchase agreements of Financing Bills (FBs) in 1986, and of Treasury Bills (TBs) in 1990
- Introduction of same-day-start operations (operations that are settled on the same day they are offered) with competitive yield auctions for outright purchases and sales of bills and for purchases of TBs/FBs under repurchase agreements. (1995)
The gradual expansion of money market operations contributed to a more market-driven system, allowing the Bank to move away from its traditional lender role. It slowly deregulated interest rates, choosing to keep them to a target level by guiding the overnight call rate. In 1991, it abolished the upper and lower lending limits for financial institutions holding Bank accounts (“window guidance”). In 1996, it discontinued in principal the provision of loans for the purpose of monetary control.
Deflationary Challenges, 1997-2006
Through the 1970s and 1980s, Japan’s large trade surpluses and high savings contributed to an appreciation of the yen against other currencies. This trend gave Japanese companies the investment capital and resources to increase their efficiency and reduce further the price of Japanese-made goods. The trade surplus widened further, increasing the value of the yen and making financial assets very lucrative. Speculation was inevitable, and by the late 1980s there was an unprecedented rise in the prices of housing, real estate, equities, and other assets (“The Asset Bubble”). [11]
The bubble burst, and by 1991, Japan’s housing prices imploded, precipitating a sharp decline in bank assets. Customers’ bank deposits were guaranteed by the state, forestalling a run on the banks, but the banks remained in prolonged crisis due to a lack of capital. The government was reluctant to provide taxpayer funds to help the banks, due to hostile public opinion, so the banks continued to struggle throughout the 1990s. [12]
Three events contributed to a further weakening of the Japanese economy in 1997-98: an increase in the consumption tax (VAT) rate in April 1997; the Asian currency crisis from July 1997 to the spring of 1998; and a subsequent deepening of Japan’s banking crisis, with the failure of the Hokkaido Takusyoku Bank, a major financial institution, in November 1997. These events precipitated a deflationary environment, where the Consumer Price Index fell for five consecutive years, from 1998-2003. [13]
On April 1, 1998, the freshly-reorganized Bank of Japan under its new governance inherited this challenging situation, and started implementing various policies to realize its mandate of price stability.
In 1999, the Bank quickly expanded the list of allowable money market operations: [14] [15]
- The purchase and sale of both FBs and TBs in money market operations, then outright purchases and sales
- The purchase of Commercial Paper (CP) under repurchase agreements
- The borrowing of Japanese Government Securities (JGBs) against cash collateral
- Competitive yield auctions for all money market operations
- Diversification of the maturity dates for transactions to increase their flexibility.
ZIRP (Zero Interest Rate Policy) 1999-2000[16]
In the deflationary environment of the late 1990s, even Japan’s traditionally low interest rates were too high. In a climate of falling prices, a zero percent interest rate is in effect a positive real interest rate (the nominal interest rate minus the inflation rate). Because a run on banks would occur if the nominal interest rate were negative (the “zero bound problem”), a zero-percent nominal interest rate policy (ZIRP) was considered by many economists to be the best alternative.
A zero percent call rate was put in place by the Bank from March, 1999, and did precipitate some modest economic growth. Over government objections, the Bank ended this policy in August 2000 and raised the interest rate to 0.25%. In retrospect, the decision to terminate ZIRP seemed premature: after a downturn in the USA economy, the Japanese economy went into recession two months later, and deflation became worse.
Quantitative Easing 2000-2006[17]
The Bank adopted a “quantitative easing policy” in March 2001, in which an increased current account balance (including excess reserves) was adopted as the Bank’s main operating target, instead of setting the uncollateralized overnight (O/N) rate in the call market. The Bank emphasized that this policy was temporary, introduced under extraordinary circumstances.
The goal of quantitative easing was to inject large amounts of excess reserves into the economy, thereby easing monetary conditions so the core consumer price index (CPI) would return to a positive value. By increasing its current account balance, the Bank could introduce more liquidity into the markets by purchasing long-term Japanese government bonds (JGBs) and other money market instruments held by commercial banks. With commercial banks parking their excess reserves at the Bank, effective interest rates for the interbank market could remain at or near zero, thereby encouraging lending.
Under quantitative easing, reserves in the banking system to support bank lending increased from the required 5 trillion yen to nearly 35 trillion yen, and effective interest rates remained at or near zero. By the end of 2005, the CPI inflation rate started showing positive values on a sustained basis. Deflationary pressures appeared to have been overcome, so the Bank terminated its quantitative easing policy in March 2006.
Ongoing Challenges, 2006-
After the Bank terminated its quantitative easing policy in March 2006, the CPI inflation rate remained stubbornly low, despite increasing demand and output.
At the time it ended quantitative easing, the Bank announced a policy of achieving sustainable output growth within an unofficial inflation rate range between 0 and 2%. Its options continued to be limited, however, because of the intrinsic difficulty of achieving inflation targeting in an environment of near-zero inflation and zero nominal interest rates. The CPI peaked at 0.7% in August, 2006, and then started to decline again. Despite the risk of deflation, the Bank opted to raise the policy rate to 0.5% in January, 2007. [18]
The monetary crisis of October, 2008 has added to the Bank’s challenges, with the added pressures of a rising yen, financial institutions under threat, and the spectre of a return to deflation [19] due to an unwinding of the commodity price spike.
Japan’s Financial System
Parliamentary System
In the Japanese Parliamentary System, legislative and executive powers are vested in the Diet (parliament), which has two houses: the House of Councillors (the upper house) and the more powerful House of Representatives (the lower house).
For most of its post-war history Japan has been ruled by the Liberal Democratic Party (LDP), which has a variety of factions that have traditionally weakened the government and stymied reform.
Economy
Japan has few national resources and is highly dependent on imports of raw materials and fuel, yet is one of the most powerful economies in the world. Contributing to Japan’s success are a strong work ethic, a collaborative relationship between government and various industries, and ongoing innovation in technology. Current challenges include an aging population that will put increasing pressure on pension funds.
As of 2008 Japan’s GDP is 500 trillion yen. Agriculture comprises only 1.7% of Japan's GDP, with services being the largest sector at 68.3% of GDP. Industrial products such as cars, electronic devices and computers are the biggest export items. In recent years, more of Japan’s exports go to the Asian economies (making it less dependent on Western markets than in the past).[20]
Recent Economic Trends
Since the asset price bubble burst in the early 1990s, Japan has been in a period of slow economic growth and occasional deflationary pressures. This period of low growth put the Japanese economy out of step with those of other G7 countries (save for Germany), so Japan did not experience the same exuberant credit and housing markets that overtook many Western countries.
After over a decade of sluggish growth, the Japanese economy was showing nascent signs of strength in recent years. House prices have been stable since Japan’s housing bubble burst in the 1990s (so less likely to fall). Consumer and corporate finances are generally in better shape than other economies. For example, by 2008 Japanese households had reduced their debt to 63% of GDP (from 71% in 2000); much lower than the debt ratios of around 100% in both America and Britain, where borrowing exploded over the past decade. [21]
The government continues to work on its balance sheet. In 2006, Prime Minister Junichiro Koizumi set a goal of balancing the budget by 2011. However, by September 2008, this goal was looking less likely to be realized. The current administration is looking at switching the economy policy by increasing spending and cutting taxes to “jump start” the economy. [22] The Japanese government's October, 2008 economic report indicated a serious decline in consumer spending and a decrease in exported goods to all world markets, and predicted further weakening of the Japanese economy. [23] The Yen is also increasing against all other currencies, which may have an additional impact on Japan’s export economy.
Related Links
General Sources
Sources (Quantitative Easing)
- Japanese monetary policy: 1998-2005 and beyond, Takatoshi Ito, p. 106
- Easing Out of Quantitative Easing, Richard Koo
- Bank of Japan, Japan’s Open Market Operations under the Quantitative Easing Policy
- Trying to Make Sense of the Bank of Japan’s Monetary Policy since the Exit from Quantitative Easing, Kazuo Ueda, University of Tokyo, December 2007
References
- ↑ Bank of Japan Website
- ↑ Ibid
- ↑ Japanese monetary policy: 1998-2005 and beyond, Takatoshi Ito, p. 106
- ↑ Bank of Japan website unless otherwise noted
- ↑ Japan’s Approach to Monetary Policy, Giovanni P. Olivei, page 1
- ↑ Quote from Wikipedia
- ↑ Ito, p. 106
- ↑ Ito, p. 112
- ↑ Bank of Japan Website, Functions and Operations of the Bank of Japan, Chapter VI: The Bank of Japan’s Money Market Operations and Lending
- ↑ Bank of Japan website, Introduction of New Measures for Money Market Operations in Response to the Recent Situations in Firms' Financing Activities
- ↑ Wikipedia
- ↑ Erroneous Assumptions in Research on Deflation, Keiichiro Kobayashi
- ↑ Ito, page 107
- ↑ Bank of Japan, Functions and Operations of the Bank of Japan, Chapter VI: The Bank of Japan’s Money Market Operations and Lending, pp. 124-5
- ↑ Bank of Japan, Introduction of New Measures for Money Market Operations in Response to the Recent Situations in Firms' Financing Activities
- ↑ Ito
- ↑ See Sources (Quantitative Easing)
- ↑ Trying to Make Sense of the Bank of Japan’s Monetary Policy since the Exit from Quantitative Easing, Kazuo Ueda, University of Tokyo, December 2007
- ↑ Japan Will Be Back In Aggregate Deflation Before Long, Economists Say, (Oct. 27, 2008)
- ↑ The Economist Pocket World in Figures, 2008 Edition
- ↑ Down but not out, The Economist, Sep 4th, 2008
- ↑ Japan Finance Head Nakagawa May Back Policy Shift, bloomberg.com, September 24, 2008
- ↑ Govt economic report recognizes impact of U.S. financial crisis, Daily Yomiuri, Oct. 22, 2008
