BANK OF JAPAN, ZERO MONEY POLICY AND DEFLATION

BANK OF JAPAN

The Bank of Japan (BOJ) is the world’s second largest national bank and is regarded as the second most powerful bank in the world after the Federal Reserve in the United States. It has a nine-member policy board and has a reputation for being slow moving and conservative and is behind Japan’s zero interest policy. Critics charge it could have done more to help pull Japan out its recession.

BOJ independence is matter of some debate. Detailed minutes from a BOJ board meeting released in 2008 reveal attempts by the government to influence board decision

The Bank of Japan is led by a governor who serves a five year term. He has traditionally come from the upper echelons of the civil service, usually the Ministry of Finance. In recent years the BOG governorship has been a position that few people have wanted.

The leaders of the Bank of Japan have traditionally been very conservative and non-interventionist. This trend changed in 2003 when Toshihiko Fukui became the head and made some unorthodox moves that were credited with helping Japan record high growth rates.

In March 2008, the selection of new Bank of Japan governor became a major political issue. When the term of governor Toshihiko Fukui was up the ruling LDP battled with the opposition Democratic Party over who would be the new choice. The LDP’s first selection, Toshiro Muto, was rejected by the Japanese upper house, which was controlled by the opposition. The opposition approved Masaaki Shirakawa as deputy governor, who by default became governor.

For a time there was no governor of the Bank of Japan, the first time in the post war period such a thing had happened. The whole episode was an embarrassment for Japan because it occurred during a period of economic upheaval when the yen was appreciating and world economy was in a crisis because of the subprime mortgage crisis in the United States.

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front of old 10,000 yen banknote

Zero Money Policy in Japan

Japan is the only industrialized country in modern history to stick with a free money policy for an extended length of time. The Bank of Japan introduced zero-interest rates in February 1999 to stimulate investment and battle deflation. In August 2000 the bank raised rates slightly above zero but returned to zero in March 2001.

In March 2006, after five years, Japan ended its super-loose. low-interest rate policy (the quantitative easing policy) and returned to a conventional policy based on interest rates,. In July 2006, Bank of Japan ended it zero interest change policy, with the board voting for a 0.25 percent rate hike. In February 2007, BOJ raise the key interest rate from 0.25 percent to 0.5 percent, the highest rate in 8½ years. In December 2008, in the midst of the global economic crisis, the Bank of Japan cut the key rate from 0.3 percent to 0.1 percent.

Japanese Government Bonds

The interest rates for three- and five-year bonds are fixed for the entire term. Ten-year bonds have variable interest rates, which are revised every six months. Three-year bonds are issued every month, while five- and 10-year bonds are issued every three months.

After a sluggish period due to low interest rates, the popularity of government bonds for individual investors is recovering. A major contributor to the turnaround is the government's revision of the method for calculating the variable interest rate for 10-year government bonds, which has resulted in higher interest rates.

Prior to the revision, the variable interest rate for 10-year bonds was set at 0.8 percentage point below the basic rate. The basic rate for individual-purchase bonds is calculated according to auction prices of 10-year fixed-rate bonds, which are sold mainly to institutional investors. The Finance Ministry changed the method of calculating the variable interest rate for 10-year bonds issued from July this year. The new method multiplies the basic interest rate by 0.66.This means that if the basic rate is lower than 2.33 percent, the return on 10-year bonds is better than under the previous system.The basic rate for July issues was 1.17 percent, and thus the interest rate of 10-year bonds for individuals was 0.77 percent per annum. The rate under the previous system would have been 0.37 percent--less than half. The interest rate for July issues of three- and five-year bonds was 0.2 percent and 0.41 percent, respectively.

Japan’s $100 Billion Credit Facility

In August 2011, Hours after the Moody downgrade was announced , the government announced a $100 billion credit facility to help the Japanese economy ride out a spike in the yen in recent weeks amid the global market turmoil, which has battered Japan’s export-led economy. “Taking into account that there is a lopsided rise in the yen, I felt that swift measures were needed,” Yoshihiko Noda, the finance minister, told reporters. [Source: Hiroko Tabuchi, New York Times, August 23, 2011]

The credit facility aims to spur Japanese spending on corporate acquisitions and resources overseas, according to a statement released by the Finance Ministry. By spending yen for dollars and other currencies, the ministry hopes that the currency will weaken somewhat. A strong yen hurts Japanese exporters because it makes their goods less competitive and erodes the value of their overseas earnings when repatriated into yen.

Some Advocate Japan Selling U.S. Treasurys

The idea that Japan would ever dump its $900 billion holdings of U.S. Treasurys, the second largest foreign ownership after China, has long been just that---an idea never seriously entertained. The long-standing argument paints a horrific picture of the consequences: The dollar would crash, world markets would be sent into a tailspin and the post-World War II military and political alliance between the U.S. and Japan would be shaken. [Source: Yuri Kageyama, AP, August 15, 2011]

But after Washington's credit rating was downgraded for the first time ever earlier this month---from AAA to AA+ by Standard & Poor's---some daring advocates are voicing that taboo idea: Why not sell Treasurys? "The holdings translate to 1 million yen ($13,000) per Japanese taking this risk in shouldering U.S. debt, all without their fully being aware of it," said Kenji Nakanishi, a lawmaker in a new opposition party that made significant gains in the last election.

Nakanishi told The Associated Press that Japan shouldn't sell all its holdings at once, but should reduce them by about 10 trillion yen ($130 billion) each year, and earmark some of that money for recovery spending in northeastern Japan, which was devastated by the March 11 earthquake and tsunami. A simple explanation to Washington that the move won't change the U.S.-Japan political and defense alliance should be enough, according to Nakanishi. It alarms Nakanishi that the government is trying to raise taxes to fix its deficit and finance the earthquake recovery, a move he fears would further squeeze the Japanese economy.

Views like Nakanishi's may be winning some acceptance. No one expects them to be acted upon immediately. The Japanese government and ruling party officials have repeatedly said Japan won't sell U.S. bonds, and instead will keep buying them. The common wisdom is that a weak dollar would prove devastating to the Japanese economy by making it more difficult for Toyota Motor Corp., Sony Corp. and other pillars of corporate Japan to sell their goods overseas.

Japan would be venturing into untested territory if it decided to reduce Treasury holdings. In 1997, mere musing by then Prime Minister Ryutaro Hashimoto about selling Treasurys set off a Wall Street plunge until Japanese officials quickly jumped in for damage control and promised Japan had no such plans. But Naoto Amaki, a writer and former government bureaucrat, thinks the time is ripe to start thinking the unthinkable. Amaki has long advocated reducing Treasury holdings, but is only recently growing optimistic that others may finally see how his view may be good for Japan.Japan, with its towering public debt, is in no position to help finance America's deficit, especially after the March 11 earthquake and tsunami, he said in a recent blog."Japan's finances were already in serious trouble. Now, we are literally being backed into a crisis of no return," Amaki said.

Around the same time people were talking about this the Japanese government said it might purchase euro rescue bonds to help address the fiscal problems of Greece and other debt-ridden European countries.

Great Deflation in Japan

Deflation causes employers to be stingy about wage increases and consumers to save rather than spend, resulting in glow growth and deciding standard of living. Martin Fackler wrote in the New York Times, “The classic explanation of the evils of deflation is that it makes individuals and businesses less willing to use money, because the rational way to act when prices are falling is to hold onto cash, which gains in value. But in Japan, nearly a generation of deflation has had a much deeper effect, subconsciously coloring how the Japanese view the world. It has bred a deep pessimism about the future and a fear of taking risks that make people instinctively reluctant to spend or invest, driving down demand---and prices---even further. [Source: Martin Fackler, New York Times, October 16, 2010]

But counterintuitive as it may seem, falling prices tend to discourage spending, not stimulate it. People hesitate to make big purchases for things they think will soon be worth less, especially homes. Economists said one reason deflation became self-perpetuating was that it pushed companies and people to survive by cutting costs and selling what they already owned, instead of buying new goods or investing. “Deflation destroys the risk-taking that capitalist economies need in order to grow,” Shumpei Takemori, an economist at Keio University in Tokyo, told the New York Times. “Creative destruction is replaced with what is just destructive destruction.” Kazuhisa Takemura, a professor at Waseda University in Tokyo who has studied the psychology of deflation said, “A new common sense appears, in which consumers see it as irrational or even foolish to buy or borrow,” said

“While the effects are felt across Japan’s economy, they are more apparent in regions like Osaka, the third-largest city, than in relatively prosperous Tokyo,” Fackler wrote. “In this proudly commercial city, merchants have gone to extremes to coax shell-shocked shoppers into spending again. But this often takes the shape of price wars that end up only feeding Japan’s deflationary spiral. There are vending machines that sell canned drinks for 10 yen, or 12 cents; restaurants with 50-yen beer; apartments with the first month’s rent of just 100 yen, about $1.22. Even marriage ceremonies are on sale, with discount wedding halls offering weddings for $600---less than a tenth of what ceremonies typically cost here just a decade ago.

But as Richard Cohen of the New York Times pointed out: “All the deflation since the great bubble burst almost two decades ago has not changed the fact that Japan has the second largest household financial assets in the world (about $16 trillion). That’s an ample cushion to angst, however frayed once-predictable careers have become.

Signs of Deflation and Stagnation in Japan

“By world standards, Japan remains rich and fairly comfortable,” Don Lee wrote in the Los Angeles Times. “Average household income is about $62,000---slightly less than in the U.S.---based on the latest government data.Japan's unemployment rate has been running 4 percent to 5 percent, about double the rate in the go-go 1980s, but still just half of the current U.S. rate of 9.6 percent. Much of Tokyo still looks rich. Sparkling towers are rising. Bullet trains run on time. Shopping districts are teeming. [Source: Don Lee, Los Angeles Times, December 2, 2010]

But discount stores are springing up too. In Tokyo's famous upscale Ginza shopping district, where real estate once sold for as much as $139,000 per square foot, the biggest new thing are stores like Forever 21, a Los Angeles chain of fashionable clothing that stresses value. Across the street, where Brooks Bros. once did business, the popular Uniqlo apparel shop now sells men's pullovers for $11 and fleece sweaters for $24.

The Toyoko Inn chain boasts of $80-a-night rooms that include breakfast. And downtown Tokyo pub manager Hiroto Matsuda slashed drink prices by half, to a little over $3 each, to keep up with the competition for salary-men customers. "It's not that their incomes have gone up or down, it's because they don't know what's going to happen in the future," he said of his customers' reluctance to frequent watering holes after work.

Mental and Emotional Effects of Deflation and Stagnation in Japan

Don Lee wrote in the Los Angeles Times, “The Lost Decade has taken an emotional toll as well. The number of Japanese suffering from depression, for example, has doubled in the last decade, with men in their 30s and 40s showing the highest rate, according to Japan's Welfare Ministry. Yuki Honda, a professor at Tokyo University who has researched Japan's young adults, attributes a good part of this problem to the difficulty that workers---even graduates of top universities---have getting good permanent jobs. [Source: Don Lee, Los Angeles Times, December 2, 2010]

"The Lost Decade made young people timid and afraid of what to do; it's made them even more risk-averse," Honda said. The Japanese have coined a name for young men who prefer quieter, less competitive lives---soushokudanshi, or herbivore men.

Other Japanese are almost fatalistic about the future, believing that things will never get better. Daigo Sato, 32, is too young to have memories of the earlier era when people were sprinkling gold flecks on sushi and thought nothing of spending thousands of dollars for the latest Gucci handbag.

"The economy has been the same ever since I graduated. I don't feel it's bad or worse, it's just the same," said the Osaka native, a college graduate who majored in history and has been working ever since as a salesman for a sake company. Previously, he said, the stock market was alive. Now, "I have my money in stocks, and they haven't done anything in 10 years."

Living with Deflation and Stagnation in Japan

On the experiences of a 45-year-old systems engineer named Hiroshi K., his wife and two children living with deflation, Don Lee wrote in the Los Angeles Times, “The 30-year mortgage on their house in a Tokyo suburb now carries an interest rate of just 2.5 percent. Recently, when the family bought a 46-inch high-definition television set, they got one-third off the $1,450 sticker price. Hiroshi's wife gets her hair done for $25, less than half the cost 10 years ago. [Source: Don Lee, Los Angeles Times, December 2, 2010]

That's the good news. The not-so-good news is that the family waited months for prices on the TV to drop; much of the price break came from government subsidies and retailer incentives. Also, Hiroshi has not seen a significant pay raise in a decade, so he's not spending more either. And his 1,000-square-foot home is worth about the same as when he bought it seven years ago.

"Because of the uncertain economy, I can't really plan our future life," Hiroshi told the Los Angeles Times, his thin face tightening ever so slightly. He said he already changed jobs five times since graduating from technical college, something unthinkable for his parents' generation. "They never had that kind of worry."

Hiroshi is old enough to remember the heady days when people talked about Japan as No. 1. Now, he said, never mind the U.S., Japan can't keep up with China and South Korea. He knows it's not all bad; he said he can afford to buy things for his children, ages 8 and 10, that he never enjoyed as a child. But Hiroshi worried that the pressures of deflation have pushed too many companies, including his, to keep driving costs down by going overseas or lowering quality."What will my children do [for a living] when they grow up if everyone looks for cheap stuff?” he asked.

Hiroshi hopes he can retire from his current company but has no illusions that his employer will keep him if sales fall. He isn't counting on his $300,000 home to appreciate. Nor does he expect Japan's pension to support him.

Martin Fackler wrote in the New York Times, “On Senbayashi, an Osaka shopping street, merchants recently held a 100-yen day, offering much of their merchandise for that price. Even then, they said, the results were disappointing.” “It’s like Japanese have even lost the desire to look good,” said Akiko Oka, 63, who works part time in a small apparel shop, a job she has held since her own clothing store went bankrupt in 2002.

“Deflation has also affected businesspeople by forcing them to invent new ways to survive in an economy where prices and profits only go down, not up, Fackler wrote. “Yoshinori Kaiami was a real estate agent in Osaka, where, like the rest of Japan, land prices have been falling for most of the past 19 years. Mr. Kaiami said business was tough. There were few buyers in a market that was virtually guaranteed to produce losses, and few sellers, because most homeowners were saddled with loans that were worth more than their homes.

Some years ago, he came up with an idea to break the gridlock. He created a company that guides homeowners through an elaborate legal subterfuge in which they erase the original loan by declaring personal bankruptcy, but continue to live in their home by “selling” it to a relative, who takes out a smaller loan to pay its greatly reduced price. “If we only had inflation again, this sort of business would not be necessary,” said Mr. Kaiami, referring to the rising prices that are the opposite of deflation. “I feel like I’ve been waiting for 20 years for inflation to come back.”

Japan’s Model of the Deflation and Stagnation and the United States

Don Lee wrote in the Los Angeles Times, “The United States---caught in the economic doldrums after the worst recession in more than a generation---is beginning to display many of the characteristics of Japan's so-called Lost Decade.Widespread layoffs and lower-paying jobs are nothing new in the United States. In recessions, U.S. companies have always cut back. But U.S. downturns also typically haven't lasted long, and they've been followed by extended boom times and bursts of hiring. [Source: Don Lee, Los Angeles Times, December 2, 2010]

What's different now is that the U.S., after the big recession, could be settling into a long period of sluggish growth with little prospect for a quick fix.Slow growth and high unemployment tend to depress consumer prices as well as home values in Japan and the United States. Also, Americans are mired in debt, and the stubbornly high unemployment rates have made people feel insecure even if they still have jobs.

Even though the Federal Reserve is holding interest rates unusually low to stimulate economic activity, it's swimming against the current because businesses are reluctant to borrow money and expand, questioning whether hard-pressed consumers will buy more. Many analysts, looking for a bright side, point out that the United States has a much more dynamic economy than Japan---with greater labor mobility and inherently more entrepreneurial energy. America's working-age population is not shrinking, as Japan's is. And perhaps most important of all, American officials have studied the policy missteps of the Japanese.

Even so, more than a few prominent economists, including Nobel laureate Paul Krugman, see the U.S. possibly sliding down a similarly dark path in which prices and wages fall and the economy stagnates. In some ways, the situation may turn out to be worse for Americans than it has been for the Japanese:

Japan's social norms and institutions provide more support for workers as well as homeowners and bank clients in trouble. "In a few years, we may envy Japan," says R. Taggart Murphy, professor of global management at Tsukuba University in Tokyo.

Japanification of the United States?

After the United States had a hard time recovering from the recession that followed the Lehman Brother’s shock there was some discussion that it might supper from “Japanification.” Martin Fackler wrote in the New York Times, “Many economists remain confident that the United States will avoid the stagnation of Japan, largely because of the greater responsiveness of the American political system and Americans’ greater tolerance for capitalism’s creative destruction. Japanese leaders at first denied the severity of their nation’s problems and then spent heavily on job-creating public works projects that only postponed painful but necessary structural changes, economists say.” “We’re not Japan,” said Robert E. Hall, a professor of economics at Stanford, told the New York Times. “In America, the bet is still that we will somehow find ways to get people spending and investing again.” [Source: Martin Fackler, New York Times, October 16, 2010]

“Still, as political pressure builds to reduce federal spending and budget deficits,” Fackler wrote, “other economists are now warning of “Japanification”---of falling into the same deflationary trap of collapsed demand that occurs when consumers refuse to consume, corporations hold back on investments and banks sit on cash. It becomes a vicious, self-reinforcing cycle: as prices fall further and jobs disappear, consumers tighten their purse strings even more and companies cut back on spending and delay expansion plans.”

“The U.S., the U.K., Spain, Ireland, they all are going through what Japan went through a decade or so ago,” Richard Koo, chief economist at Nomura Securities, told the New York Times. He recently wrote a book about Japan’s lessons for the world. “Millions of individuals and companies see their balance sheets going underwater, so they are using their cash to pay down debt instead of borrowing and spending,” he said.

Image Sources: 1) coins and old banknotes markun.cs.shinshu-u.ac.jp 2) new banknotes Big Globe net and zentech.com

Text Sources: New York Times, Washington Post, Los Angeles Times, Daily Yomiuri, Times of London, Japan National Tourist Organization (JNTO), National Geographic, The New Yorker, Time, Newsweek, Reuters, AP, Lonely Planet Guides, Compton’s Encyclopedia and various books and other publications.

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© 2009 Jeffrey Hays

Last updated October 2012

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