2017 Reports

Difficulties and Challenges: Japan’s Post-War History of Economic Trends and Monetary Policy

Suzuki, Yoshio

This is a summary paper of the author’s book in Japanese, Difficulties and Challenges, Japan’s Post-War History of Monetary Policy and Economic Trends (Iwanami Shoten, 2016). For the Bank of Japan, these 70 years are indeed a repetitive succession of difficulties and challenges, and resulting successes and failures. The first difficulty was to pursue two contradictory policy purposes, namely stimulating investments to restore supply capacity and depressing hyper inflation more than 300% under a fixed exchange rate in the Occupation period. Unexpectedly, an enormous increase in external demand generated by the Korean War in 1950-51 solved the dilemma and the pre-war level of the Japanese economy was restored in 1953. The successful catch-up story of extraordinary rapid growth started thanks to the Bretton Woods System under which free trade, capital, and technology transfer enabled Japan to perform export-investment led high growth and to achieve industrialization around 1970.
Then three surprise shocks came from abroad: the so-called Nixon shock followed by the Smithsonian Accord in 1971; the Plaza Accord and Louvre Accord in 1985-87; and the Lehman shock in 2008. Each shock caused sharp appreciation of the yen, but the economic implications from each are different. The essence of the first is a correction of the depreciated yen under the fixed nominal exchange rate system in which the effective real rate of the yen had been in a depreciating trend because of the inflation rate differential between Japan and abroad. Japan’s policy reaction was so extreme as to cause domestic inflation which further flared in the first oil crisis.
The second shock would have been also smaller if the binding of Japanese monetary policy by participating in the so-called “International Policy Coordination” program had not caused asset bubbles as the consequence of an internationally-compelled easy money policy.
The third was a real shock because it spoiled the successful exit from deflation and turned “the loss of 7 years” to “15 years”.
The story of successful “Stronger Country” Japan in 1975-84 and the failure of too hasty fiscal consolidation in 1997 which resulted in extended deflation are also discussed. As for today’s monetary policy, since the final goal of full employment is almost achieved, pursuing an intermediate target of 2% inflation rate is meaningless, and the BOJ should start the exit policy. A positive immigration policy to increase Japan’s working population is also proposed to raise the potential growth rate and the natural rate of interest to recover the effectiveness of monetary policy.