Japanese Monetary Policy: Experience from the Lost Decades

Abstract

I. INTRODUCTION Soon after achieving full independence as a central bank in 1998, the Bank of Japan (BOJ) found itself embarked on stormy seas. Its independence compares favorably with global standards, but it has sometimes faced harsh criticism and its path has often been a challenging one. The challenges faced by the BOJ actually date back two decades. As the 1990s began, Japan confronted the legacy of its collapsed bubble economy. Massive obstacles--termed the in debt, capacity, and employment--blocked the way. These obstacles prevented a smooth recovery in the Japanese economy for more than 10 years. (Figure 1 and Figure 2) A look at the financial factors behind the three excesses just noted shows that excess debt required borrowers to continue to repay obligations until they could return to an optimal level of leverage. At the time, this process was a severe one since lenders (banks) were likewise required to cut lending to boost their capital position, which had been impaired by the accumulation of nonperforming loans (NPLs). In these circumstances, it is easy to see that standard monetary easing, in which interest rates were cut to boost bank lending, could not work. [FIGURE 1 OMITTED] [FIGURE 2 OMITTED] II. THE JAPANESE ECONOMY SINCE THE 1990S Before discussing unconventional monetary policies in Japan, to clarify the background to their adoption it is better to begin with an economic preface. After Japan's bubble economy burst at the start of the 1990s, the economic slump continued for more than two decades. (1) Much discussion has focused on pinning down the causes. Some views cite cyclical factors, while others regard the problems as structural. Here, five prominent views can be mentioned. The first view emphasizes financial factors. According to this conception, the Japanese financial sector had suffered NPLs until the early 2000s. Banks acted to restrain credit, which reinforced economic sluggishness and created further bad assets. This created a vicious circle. The second view focuses on the central bank's policy stance. As mentioned, in 1998 the BOJ had achieved full independence in terms of monetary policymaking. Some have argued that conservative policies by the independent central bank put deflationary pressure on the Japanese economy. The third view emphasizes labor market reform. During the bubble economy period of the late 1980s, heavy reliance on overtime work was a key element in numerous sectors of Japan's economy. Cases of sudden death through overwork received media attention, and overtime work was made a topic of social concern. Reform of the labor market became an urgent issue. As a result, in the 1990s legal restrictions on total labor hours were introduced and actual working hours dropped. It has been argued that this reduced the potential for economic growth. (2) The fourth view also focuses on labor issues. This conception notes that Japan has suffered rapid population aging and that the labor force peaked out in 2005. It is argued that the reduction of the labor force has acted to suppress economic growth. While combating prolonged deflation, the BOJ has stressed demographic factors as a cause of deflation and argued for the necessity of a wide range of structural reforms such as a boost in women's participation in the labor market and further innovation in Japanese industry. (3) Finally, the fifth view focuses on intensified global competition. In the 1990s, Japan's neighbors in Asia posted higher economic growth. In Japan's low-value industries, competition with China accelerated, while relatively high-value industries faced greater competition from South Korea and Taiwan. Japan's reputation has been that of an economy which is good at applying technology but weak at nurturing innovation. This has left it in a difficult position given the rapid globalization that has progressed since 1989, when the Berlin Wall collapsed. …

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