2002 Japan Conference: A Summary of the Papers

I was initially reluctant to give a public speech so soon, less than six months after my term as board member expired in March 2002. But here I am, because my old friend from Harvard days, Albert Ando, was scheduled to chair the session and also because of the insistence of one of the organizers (Fumio Hayashi). It is a real pleasure to speak to this audience nonetheless.

First let me introduce myself. I did graduate study at Harvard. I am a member of the Mont Perlin Society, as well as a life member of the Royal Economics Society. The annual prize awarded by the Japanese Economic Association (the Japanese equivalent of the John Bates Clark Medal) bears my name as founder. Before serving on the BOJ's board, I was the CEO of Tonen, a major Japanese oil refining company.

Now let me go straight to the issue of monetary policy. My view has been clear and consistent: the Japanese economic situation is more serious than commonly supposed and the BOJ should be more aggressive in easing. You can see this from my press conference remarks on the very first day of my term on April 1, 1998, and the proposals for policy directives I put forth at numerous BOJ policy board meetings. Let me elaborate by focusing on several major turning points in the decisionmaking by the policy board.

The belated rate cut of September 1998

At board meetings starting with the June 12, 1998 meeting, I proposed to cut the overnight call rate (the Japanese equivalent of the federal funds rate). At each of those meetings, my rate cut proposal was voted down. The argument against the cut was to wait and see the effect of the fiscal stimulus package announced in late April. I argued then, and repeatedly thereafter, that monetary and fiscal policy should be synchronized in their implementation. On September 9, 1998 the board made a 180-degree turn and voted to cut the rate to 0.25 percent, precisely the level I had proposed in the previous board meeting.

The start of the zero-interest rate policy (ZIRP) in February 1999

Despite the rate cut, the Japanese economy showed no sign of recovery. My proposal from November 1998 on was to cut the overnight rate further. On February 12, 1999 I took a further step and proposed a directive calling for quantitative easing by setting the overnight rate as low as possible, initially at 0.10 percent and then at lower levels. The governor's proposal at that board meeting -- namely, to set the overnight rate initially at 0.15 percent and then lower -- made no reference to quantitative easing. Nevertheless, it was obviously a step in the right direction, so I voted for it. I think the quantitative easing that actually took place in late February to early March contributed greatly to the rapid recovery of stock prices and the subsequent economic recovery.

The monetary base targeting with inflation targeting

The proposal that I put forth beginning on February 25, 1999 had two components: to set an inflation target and to set a target for a specific amount of excess reserves consistent with a 10 percent -- and subsequently higher -- growth rate of the monetary base. My proposal was voted down repeatedly.

The removal of the ZIRP on August 11, 2000

At a board meeting in November 1999, I was the first to point out that a recovery was underway. Nonetheless, I believed that further easing was needed and stuck to my proposal of the base-and-inflation targeting, because the deflation gap was still substantial. The majority view of the board was more optimistic, and became even more so in the spring of 2000. On August 11, 2000 the governor proposed to end the ZIRP by raising the overnight rate to 0.25 percent. The government's request to postpone the vote, after a heated discussion about the nature of BOJ independence, was rejected by the board, with the only assenting vote coming from myself. Regarding the governor's proposal to end the ZIRP, I cast a dissenting vote. I stuck to my position in all subsequent meetings by dissenting to the board's decision to maintain the 0.25 percent rate.

The introduction of quantitative targeting on March 19, 2001

With falling prices and output, it became clear that the termination of the ZIRP was a grave mistake. In February, the board reversed its course by a cut of the overnight rate to 0.15 percent, the level that prevailed in the initial phase of the ZIRP. Finally, on March 19, 2001 it voted for quantitative easing. For the first time in its 120-year history, the BOJ decided to do what it had been saying was impossible, namely, to target reserves instead of the overnight rate. The policy directive also stipulated that this policy last until the CPI inflation rate becomes zero or positive. This is not genuine inflation targeting, because neither the upper bound nor the time horizon is specified. Nevertheless, the directive incorporated the fundamental change that I had been advocating all along. The board finally came through. I was deeply moved.

The reserve target remained too low

The degree of quantitative easing since the regime change of March 19, 2001, however, was not enough because the adopted reserve target of 5 trillion yen is the minimum amount required to maintain zero interest rates. This is just a ZIRP in disguise! My proposal to raise the target well above that amount was voted down repeatedly. The majority view of the board is none other than the so-called BOJ doctrine: that a central bank should act passively, supplying reserves merely to accommodate demand. Hence their insistence, which later proved plain wrong, that there is a unique level of reserves consistent with zero interest rates and that a central bank cannot increase the supply of reserves over and above that upper bound. But again, the board turned around my way and increased the target to the 10 to 15 trillion yen range in December 2001 (I cast a dissenting vote because the target should be a level, not a range, and because the range was far too wide). Thanks to the increased reserve target, the monetary base, which grew 14 percent on year-on-year basis in September 2001, picked up its pace and grew 36 percent in April 2002. Regrettably, the growth rate since then has been declining (about 25 percent in September, and 20 percent in December 2002).

So, despite initial resistance, most components of my proposal eventually were incorporated in the board's directive. Let me conclude with my current view on monetary policy. First, the BOJ should adopt the rest of my proposal, namely inflation targeting and more active and aggressive easing, particularly when excessive bank lending has rapidly been corrected. Second, the quantitative easing should proceed continuously, without letups. The quarter-to-quarter growth rate of the base should be about 5 to 6 percent. Third, to end current deflation, there should be an accord between the government and the BOJ to engineer a monetization of government deficits needed to finance additional government spending that would raise the productivity of the Japanese economy. That is, the government should increase spending and the BOJ should match it by conducting an open-market purchase of an amount equal to the increased spending.