Unconventional monetary policy lessons from Japan

Masaaki Shirakawa, Governor, Bank of Japan in his recent speech reviews unconventional mon pol and lessons from Japanese experience. He says there are 5 challenges which Jap policymakers found difficult to overcome:

First, the most essential point in dealing with a financial crisis is to maintain the stability of financial markets and the financial system.

Second, as I mentioned, in order to stabilize the financial system, the injection of capital into the banking system together with the provision of liquidity is indispensable.

This raises the third point.  The unwinding of various excesses which have built up in the non-banking private sector is just as critical.

The fourth issue is the fine line between monetary policy and fiscal policy.  Measures to take on individual credit risk such as corporate debt are extraordinary steps for a central bank since they come close to the area of fiscal policy which deals with resource allocation at the micro level.

Fifth is communication with the markets.  Without public trust in the organization, a central bank cannot effectively conduct monetary policy.  Words and deeds have to match.  There is much uncertainty with regard to the effectiveness of unconventional monetary policy and extraordinary measures may be pushing the boundary of monetary policy.

As each crisis is different in magnitude the nature of five challenges would differ.

He then winds up with the typical BoJ response to this crisis:

The five issues I raised today were those which the Bank of Japan struggled to solve when it last embarked on unconventional monetary policy.  The difference between now and then is that the practical difficulties in dealing with such issues were not fully appreciated by many economists at that time.  

I am sure many of you can recall the various policy recommendations that were made toward Japan’s policymakers by economists, both domestically and from abroad, as well as from international organizations since the latter half of the 1990s.  Recommendations, some of which were quite bold, were made to the Bank of Japan.  Typical recommendations were: “all that the Bank of Japan needs to do is to set a high inflation rate target and purchase all types of assets including physical assets to achieve that target”, and “the Bank of Japan should monetize the government’s budget deficit”.  One of the most famous was, “the central bank should credibly promise to be irresponsible”. 

 Interestingly, in the current crisis, in spite of the sharp contraction of the economy, very few similar bold recommendations are being made by economists, and such radical measures are not being implemented.  As we experience first time challenges, the discussion surrounding policy measures tends to swing between the extremes.  Such discussions become truly practical once people actually face the challenge of dealing with a crisis.


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