Bank of Japan
The Bank of Japan was established in 1882, under the direction of the Ministry of Finance, to be the sole issuer of convertible notes in Japan. The first substantial revision of the Bank of Japan Lawoccurred in 1942, when the central bank was given the broad objective to conduct its operations ‘‘solely for the achievement of national aims’’. There was nomention of financial or price stability, and the law was designed to support Japan’s wartime military effort (Cargill, Hutchison, and Ito 1997 and 2000). In response to the triple-digit inflation in Japan immediately after World War II, in part due to monetization of government deficits, a change in the Finance Lawwasmade in 1947 that provided the Bank of Japan a degree of independence fromgovernment deficit financing (e.g., prohibiting the bank from underwriting government bonds or making loans to the government except under some conditions).
In 1949 the Bank of Japan Law was again amended, mainly to provide an overall management structure to the bank by establishing a Policy Board consisting of five voting and two nonvoting members. The Policy Board was given primary authority for almost every aspect of monetary and financial policy operations of the Bank of Japan. Although the Ministry of Finance held a nonvoting position on the Policy Board, the Bank of Japan Law gave the ministry overall control over the bank and the ability to influence policy decisions, if not to determine them outright. For example, the cabinet had the authority to dismiss the governor and vice governor, and the minister of finance could dismiss executive directors, auditors, and advisors of the Bank of Japan ‘‘whenever it is deemed particularly necessary for the attainment of the objective of the Bank’’.
New Bank of Japan Law
The basic institutional and legal framework governing the Bank of Japan was unchanged during most of the postwar period until creation of the ‘‘new’’ central bank under the changes of the law in 1998 (Cargill, Hutchison, and Ito 2000). A number of economic and political events prompted the change in the law, including widespread dissatisfaction with the Ministry of Finance’s handling of the serious banking problem. In particular, the Ministry of Finance was slow to address the bank’s nonperforming loan problem (brought on by the collapse of the bubble economy, recession, and poor lending practices), the liquidation of the jusen industry (subsidiaries of financial institutions specializing in real estate loans), and other aspects of its response to the financial crisis that had burdened Japan since the early 1990s.
The 1998 Bank of Japan Law fundamentally changed the formal operating objectives of the central bank, its formal relationship to the government, its role in banking supervision, and other functions. Two elements are central to the reform. First, unlike the 1942 law, the new law specified two operating principles for currency and monetary control: the pursuit of price stability and the maintenance of an orderly financial system. The law clearly states that the Bank of Japan is responsible for price stability and shares responsibility for financial stability with other parts of the government. Second, the bank was given much more autonomy from the government and in particular from the minister of finance. The new law states, for example, that autonomy for monetary and currency control shall be respected, and the Ministry of Finance’s power to remove Bank of Japan officers was significantly limited. A number of other important changes were also made in the new law, including in the areas of governance and policy formulation, transparency and accountability, budgeting, lenderof- last-resort functions, exchange rate intervention, and government financing.
Conduct of Monetary Policy
The conduct of monetary policy has gone through a number of distinct changes during the postwar period. The years immediately following the warwere characterized by a chaotic environment and triple-digit inflation during 1946 48. From the mid-1950s to the early 1970s, Japanesemonetary policy operated under the constraints of the Bretton Woods fixed exchange system, a period of very high growth, economic progress, and moderate inflation. The early 1970s were again a chaotic period: buffeted by the first oilprice shock and double-digit inflation (called ‘‘wild’’ inflation), Japan struggled to recover a nominal anchor following the breakdown of the BrettonWoods fixed exchange rate system.
The Bank of Japan then introduced a ‘‘moneyfocused’’ monetary policy in the mid-1970s that served to gradually lower inflation and then keep it at low levels, combined with very strong economic performance through the 1980s (Hutchison 1986). The Bank of Japan, despite its legal dependence on the Ministry of Finance, and facing the constraints imposed by the wartime conditions of the 1942 law, achieved an extremely successful policy record from 1975 to 1990. The price stabilization record of the Bank of Japan, combined with sustained real growth of the Japanese economy during this period, attracted international attention. The Bank of Japan appeared to be a stark exception to the conventional wisdom that the legal independence of central banks is necessary to generate good inflation records (Cargill, Hutchison, and Ito 1997). The biggest dilemma the Bank of Japan faced at the end of this period the latter part of the 1980s was how to respond to sharp increases in asset price inflation (in retrospect identifiable as an asset price bubble) without affecting other aspects of the economy, which otherwise seemed to be performing well, with strong economic growth and low price inflation overall.
The 1990s brought a completely new set of challenges for the Bank of Japan. The country faced a period of stagnation from 1991 to 2003, with real gross domestic product growth averaging only 1.5 percent, about half that of the rest of themembers of the Organisation for Economic Co-operation and Development and much less than Japan’s historical norm. During much of the stagnation Japan experienced prolonged deflation, or essentially zero price changes, and a sustained period of near-zero shortterm interest rates when the central bank seemed unable to provide additional stimulus to the economy (Hutchison, Ito, and Westermann 2006). During this latter period, much of it when the Bank of Japan was operating independently under the new law, the bank came under severe criticism for not preventing price deflation and not doing more to stimulate the economy. Whether the Bank of Japan could have, or should have, operated differently during this period remains an open question. See also Bretton Woods system; European Central Bank; exchange rate regimes; Federal Reserve Board; monetary policy rules; money supply