For the past five years, the Bank of Japan (BOJ) has employed an unconventional monetary easing policy, called quantitative monetary easing. Under a zero interest rate regime, the BOJ shifted its tool for monetary easing from interest rates to quantity of money, thus providing the money market with much more money than it needs. It is difficult to find evidence that this monetary easing has contributed to the current economic recovery. What we can show is that this quantitative easing diluted the functions of interest rates in the money market, with the following consequences: quantitative easing hid the risks of the huge amount of fiscal debt and supported troubled commercial banks. Hence it helped to prevent both fiscal and financial crisis.
How did such a policy come about? It is misleading to suppose that the BOJ, which gained legislative independence in 1998, decides its policy on its own, or, conversely, to assume the government controls the BOJ completely. The conflict between the BOJ and the government should be carefully examined. In that sense, these two consequences have different stories. Preventing fiscal crisis had been an implicit agenda from the beginning of the conflict between the BOJ and the government. The BOJ tried to reject this implicit agenda at first, but finally accepted it to compensate for its own political failure in raising interest rates. The process shows that this implicit agenda has gradually become explicit. By contrast, supporting troubled banks was an unexpected consequence, which in the end helped the BOJ to defend its policy.
The situation has become complex amid the current economic recovery. The need to restore the function of interest rates has been rising. The need to support troubled banks has decreased, but supporting the fiscal debt still remains critical issue, since it has grown to a dangerous amount. Monetary policymakers therefore face a contradiction. Strategies for separating monetary policy from the management of government bonds, while avoiding fiscal crisis, are needed.
About the Author: Tetsufumi Arita has been a reporter for the Japanese newspaper, Asahi Shimbun, since 1990. He has extensive experience in reporting business and political news. Arita was a visiting fellow at the Walter H. Shorenstein Asia-Pacific Research Center between 2004 and 2005.