Japan Case Study

9-708-017

REV: APRIL 9, 2009

LAURA ALFARO AKIKO KANNO

Kinyuseisaku: Monetary Policy in Japan (A)

By the fall of 2007, over a year had passed since the Bank of Japan (BOJ) had abandoned the zero interest rate policy (ZIRP). Japan was experiencing a gradual business recovery that had lasted more than 65 months, the longest in its postwar history. Confident that the worst was over, the BOJ had increased interest rates twice during the past year. Toshihiko Fukui, the governor of the BOJ, commented at a press conference held after the BOJ raised rates in early 2007 that “the benchmark rate of 0.5% is extremely low for an economy with a 2% real growth rate.”1 Many analysts believed that Fukui did not want to repeat the bank’s mistake of the 1980s when its lax monetary policy fueled a bubble economy; the collapse of the bubble condemned Japan to years of deflation and low growth.2 Real estate prices in some of the metropolitan areas had started to rise and Fukui was concerned about the possibility of a new burst of inflation. “To prevent anything like that happening again, Mr. Fukui has insisted the bank adopt a more forward looking approach,” reported The Economist.3 Japan’s ZIRP was originally designed to help firms and banks burdened by debt; but with much healthier balance sheets, the subsidy was no longer needed. Normalization of interest rates would also promote further restructuring of “zombie companies.” Economists noted further adverse effects of the prolonged low interest-rate policy. Cheap money could promote inefficient investments; and low rates might discourage consumers from spending, since Japanese households enjoyed high levels of savings. Others, however, were quick to criticize a possible rate hike, fearing a rerun of August 2000 when the BOJ raised rates prematurely, killing off a nascent recovery and aggravating Japan’s deflation. Although the economy had enjoyed five years of growth, it was still haunted by falling prices. The core measure of...