The Monetary Policy in Japan - Essay Example

The Monetary Policy in Japan Introduction The easy monetary policy of Bank of Japan started during the prolonged recession in 1985. This period has been characterized by the rapid decline in asset prices and the mounting of non-performing assets. These non performing loans had cause distress in the banks’ financial performance and became reason for panic in the financial economy of Japan. The trade imbalance and huge trade deficits of Japan’s trade with US, UK, France and West Germany caused them to forge an agreement to maintain a lower discount rate.

To fortify this, US Congress took the stance in the increasing Japanese trade surplus to retaliate in trade measures. (Miyagawa, S. and Morita,.M. 2005) The cooperative agreement of the nations lowered the interest rate to 5.2 to Japan and 7.2 to US, a down from its former 10 per cent rate. Other policies and trade agreement as in Louvere Agreement in 1987 further reduced the interest rate in Japan to 2.5 percent, and was done to avoid world depression. Intervention from the Central Bank of West Germany returned the monetary policy to neutral level of 4.

5 per cent. BOJ had to take an easy monetary policy because at that time of 1987, the dollar was weak against the yen, and any further increase in interest rate would further depress the US economy. A period of easy funds followed, and banks gave out aggressive loans to large firms and to households with the belief that the “good times” will last longer. Along with this is the rapid increase of stock prices and asset prices, followed by the increase in interest rates from 2.5 percent to 3.

75 percent with asset prices continuously increasing. The period 1990-1993 started the asset price decline when the interest rate was increased to 6.0 by the CB Governor to avoid inflation caused by the Gulf War. In the mid of 1992 asset prices plummeted to a record low bringing the discount rate from 6.0 percent to 2.5 percent. In 1994 several adverse factors affected the economic policies further prompting the CB to lower discount rates to 0.5 in 1995. At that time, reports said bad loans had amounted to 40 trillion yen (estimated to be 4% of total loans held by financial institutions) (Miyagawa & Morita).

To bail out financial institutions, BOJ further reduced the interest rate to 0.25 percent in 1998 and 0.1 percent in 1999. BOJ had committed to maintain this policy until the market retains stability. End of zero rate policy On March 8, 2006, a news report said that BOJ has announced the end of the loose monetary policy and the return to the usually accepted interest rate, but will still keep the zero rates for the short term loans for a while. This step was seen as an eventual return to normalcy as news report said BOJ believed that deflation has been “beaten, (The Age.com 2006). Discussions: If I were the President of BOJ, should I decide to increase or decrease interest rates. .The forecast of interest rates done by the Japan Central Bank on a time series show interest rates to be still falling on a zero rate level up to year 2018.

(Chart 1 ) Meantime, forecast of US prime interest rate for 2009 will remain in the 3.61 level way below in the 2007 level of 7.5. Chart 2 (Market Vector, 2008) Chart 3 shows downward slope of discount rates of BOJ from a 6.0 percent in 1990 and was pinned to zero rate in 2002 until 2006. Chart 4 shows Bank of Japan interest rate policy with over night charges forecast. From the above BOJ experience, increase or decrease of interest rates is interplay of market forces or by external and internal intervention.

The President of BOJ cannot just adopt a financial policy as it will affect its trading partners in other countries and should consider its inflation or deflationary effect. Any market interventions will have to be agreed upon by the big players of Central Banks in affected world markets BOJ cannot afford any more reduction of discount rates and therefore, should take other measures to expand purchasing power and to bail out of financial institutions by pumping in additional capital. The President cannot increase discount rate as it is tied up with other countries’ prevailing discount rates, and it could not go much higher than the US. End. Word count: 722 Annexes Chart 1 Japan CB Discount Rates Forecast 2000 1 .

50000 2000 2 .50000 2000 3 .50000 2000 4 .50000 2001 1 .36667 2001 2 .25000 2001 3 .20000 2001 4 .10000 2002 1 .10000 2002 2 .10000 2002 3 .10000 2002 4 .10000 2003 1 .10000 2003 2 .10000 2003 3 .10000 2003 4 .10000 2004 1 .10000 2004 2 .10000 2004 3 .10000 2004 4 .10000 2005 1 .

10000 2005 2 .10000 2005 3 .10000 2005 4 .10000 2006 1 ?0?8?5 2006 2 .?8?2? 2006 3 ?0?6?6 2006 4 .?8?5? 2007 1 ?0?3?0 2007 2 .?7?0? 2007 3 ?0?5?0 2007 4 .?7?7? 2008 1 ?0?4?5 2008 2 .?6?2? 2008 3 ?0?2?3 2008 4 .?6?5? 2009 1 ?0?1?1 2009 2 .?5?5? 2009 3 ?0?9?3 2009 4 .?4?9? 2010 1 ?0?4?2 2010 2 .?4?1? 2010 3 ?0?3?4 2010 4 .?4?5? 2011 1 ?0?9?5 2011 2 .?3?5? 2011 3 ?0?7?

6 2011 4 .?3?0? 2012 1 ?0?4?9 2012 2 .?3?6? 2012 3 ?0?2?7 2012 4 .?3?2? 2013 1 ?0?9?7 2013 2 .?2?3? 2013 3 ?0?8?9 2013 4 .?2?0? 2014 1 ?0?5?9 2014 2 .?2?6? 2014 3 ?0?5?4 2014 4 .?2?3? 2015 1 ?0?2?0 2015 2 .?2?4? 2015 3 ?0?1?5 2015 4 .?2?1? 2016 1 ?0?9?2 2016 2 .?1?5? 2016 3 ?0?9?6 2016 4 .?1?3? 2017 1 ?0?7?0 2017 2 .?1?0? 2017 3 ?0?6?3 2017 4 .?1?8? 2018 1 ?0?5?1 2018 2 .?1?9? 2018 3 ?0?4?1 2018 4 .?1?7? Source: Economagic.

com Chart 2. US Prime Interest Rate Past Present and Future. Source: Market Vector Chart 3. Source: Economagic Chart 4. Bank of Japan interest rate policy Source: Economagic.com References Economagic.com: Economic. Series Title Central Bank Discount Rates (Japan) [on line] Available from http://www.economagic.com/em-cgi/data.exe/bjap/ehdis01 Retrieved 23 Jan. 2009. Market Vector. 23 Nov. 2008. U.S. Prime Interest Rate Forecast Percent Average of Month. [on line] Available from http://www.

marketvector.com/interest-rate/prime-rate.htm > retrieved 23 Jan. 2009 Miyagawa,S. and Morita, Y. Sept. 2005. Lessons from Japan’s Prolonged Recessions. Tampere Economic Working Papers Net Series. [on line] Availabe from http://www.tampub.uta.fi/econet/wp44-2005.pdf Retrieved 23 Jan. 2009 The Age.com. 03 March, 2006 Japan ends zero rates monetary policy [on line] Available from http://www.theage.com.au/news/Business/Japans-ends-zero-rates-monetary-policy/2006/03/09/1141701624496.html > Retrieved 23 Jan. 2009.