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Japanese monetary policy
Japanese Monetary PO&Y, edited by Kenneth J. Singleton (University of Chicago Press, for the National Bureau of Economic Research, 1993), 195 pages. Review by PAUL D. McNBLIS
This book brings together six papers presented at a National Bureau of Economic Research Conference on Japanese monetary policy, in April 1991. The focus of the papers is on the modus opermdi of monetary policy: (1) are short-term interest rates the operating targets of monetary policy, (2) could monetary policy have done better with a money-supply rule, (3) what information can we obtain from the term structure about Japanese monetary policy, (4) does monetary policy have real effects? Unfortunately, the papers do not take up the volatility of asset prices, especially share market and land prices, nor do they discuss monetary coordination issues. All of the papers are rigorous, make use of state-of-the-art empirical methods, and draw clear-cut policy implications from their analysis. The book is especially useful for graduate students considering dissertation topics on monetary problems of East Asian economies, since it shows how one can put the latest tools to work in this area, and how one can combine rigorous econometric analysis with interesting, sometimes fascinating, institutional detail. The book also shows us what we can get from this type of analysis, and what questions about Japanese monetary policy remain controversial and unanswered. The major problem confronting any empirical analysis of Japanese monetary policy is parameter stability: the markets have been undergoing an evolving process of liberalization and openness during the past decade, so structural change is an intrinsic part of the econometric analysis. Thus, the researchers must look for proxy variables which capture the process of structural change, or use methods which do not require structural relationships with unchanging coefficients. At best, however, the results of the analysis capture evolving relationships. Rather than present a chapter-by-chapter summary, I will concentrate on three papers that most appeal to me, and then offer brief summaries of the remaining three. Chapter 4, ‘The Interest Rate Process and the Term Structure of Interest Rates in Japan”, by John Campbell and Assisi Hamao, is a vintage John Campbell piece. The authors show us how to blend good dynamic theory with good dynamic econometrics, Pad D. MeNdis Jownal
ofAsho
l
Gmqetown
University, Department of l?.cmomi~, Washington, DC 20057.
Esonomk8, Vol. 5, No. 51994,
pp. 291-294.
copyright 0 1994 by JAI Press, Inc. h am fw
ISSN:S$&of
291
292
JOURNAL OF A!3AN ECONOMICS, (5)2,1994
withod OV@bUdklg thenadtr with technical de&l. While the data reject expectations theories of the term structure, they show that interest rate spreads help forecast short-term interest rates, and they show there is no evidence of “excess volatility” in the returns on long-term government bonds, since the actual volatility is roughly equal to that predicted by the expectations theory. Chapter 3, “Japanese Corporate Investment and Bank of Japan Guidance of Commercial Bank Lending”, by Take0 Hoshi, David Scharfstein, and Kenneth J. Singleton, offers an assessment of the aggregate macro and distributional effects of the “window guidance”, or direct credit restrictions, exercised by the Bank of Japan in the years prior to the liberalization of the mid- 1980 s. In this chapter, the authors provide a fascinating review of recent Japanese-language articles which examined the effectiveness of such guidance. They explain why some authors consider such guidance to be ineffective: since the loan limitations are only imposed on a subset of institutions, other institutions take up the slack. However, they also review counterarguments: increased window guidance leads to a lower call rate, which induces not only more lending by banks subject to window guidance, but also larger holdings of excess reserves by both types of banks. To explore the issue of window guidance, the authors use as an indirect measure of BOJ guidance or proxy variable the proportion of loans to corporations from financial institutions that are restricted by guidance, to total loans by financial institutions. This ratio declines during periods of monetary tightening, and is relatively high or rising during periods of monetary ease. The authors then use a VAR model relating this variable to the call rate, to growth rate of the real capital stock, and the growth rate of the real capital stock, and the growth rate of inventories of corporations. They find that the proxy variable has significant effects on both capital stock and inventory growth rates, and that there is little evidence of feedback from other variables to this proxy. They conclude that changes in this variable represent Granger exogenous shocks to the stance of monetary policy. The authors examine the distribution effects of window guidance through the . analysis of panel data. They conjecture that firms which belong to keirtis~ or group affiliations are less affected by window guidance than independent firms. They find that group firms tend to invest more during the period of tight monetary policy, that their investment is less constrained by liquidity, and that the difference in the sensitivity of investment to liquidity between group and independent firms is especially large during periods of tight monetary policy. Chapter 6, “An Aggregate Demand-Aggregate Supply Analysis of Japauese Monetary Policy, 1973-1990” by Kenneth D. West, develops an unrestricted re&ced-form vector-autoregressive (vAR) representation from a six-equation aggregate demandsupplymodel.From the reduced form, West obtains variance-decomposition estimates which show that money supply estimates do not account for a large share of the variance of any of the variables of the model, except the money supply itself. West also examines the effects of alternative money-supply rules. He fmds that actual outcomes and hypothetical outcomes form a constant monetary growth rule are
Book Reviezu
293
quite similar. west is careful not to interpret this result as evidence thatthe Bankof Japanfollowed a monetarist doctrine in practice, if not in announced policy.Rather, Westraises the issue that if the Bank of Japan was pursuing an activist stabilization policy, such policy had little effect on the economy. Three other papers examine the procedures and real effects of Japanese monetary policy. Chapter 1, “A Comparative Perspective on Japanese Monetary Policy: Shortrun Monetary Control and the Transmission Mechanism”, by Kazuo Ueda, argues that the policy target of the Bank of Japan has been the call rate, at least in its daily operations. While monetary aggregates and loans also predict real variables fairly well, Ueda argues that the call rate and bank lending Granger-cause other monetary indicators. Chapter 2, “Market Operations in Japan: Theory and Practice”, by Kunio Okina, qualifies the results of Ueda’s analysis. Okina argues that interest rate determination has an endogenous element. One should see the process of pursing monetary policy is a dialogue between the Bank of Japan and market participants. Finally, Chapter 5, “Monetary Policy and the Real Economy in Japan”, by Hiroshi Yoshikawa, analyses the impulse-response functions derived by a five-equation model of Japan, with interest-rate smoothing. In contrast to West’s analysis, Yoshikawa’s results lead him to reject both old and new monetarist models of the business cycle. The focus of this NBER conference volume is on Japanese monetary policy. During the 1980’s Japan’s trade surplus surged, in tandem with US. fiscal deficits and the quantity of U.S. external debt. While the book takes up the effectiveness of Japanese monetary policy operating procedures on the real sector of the economy, it is hard for readers to pay close attention to the arguments, pro and con, relating to this issue. We know that changes in bonds, especially the massive changes that took place in the 1980’s, in contrast to changes in money, lead to permanent changes in the relative prices of assets, and thus to changes in the lending opportunities in international financial markets. The international transmission effects of U.S. fiscal policy, and the ensuing wealth effects these policies caused in Japanese capital markets, appear to be far more interesting research issues, than the neutral or non-neutral effects of operating procedures of the Bank of Japan. While different chapters of the book offer contrasting results on monetary policy neutrality, one wonders if this issue merits further care. In conclusion, the book offers interesting insights into the operating procedures of the Bank of Japan during the process of liberalization of its financial markets, and offers researchers examples of how good econometric techniques can be applied to financial markets in such transition processes. However, as these markets become more open and internationalized, the peculiar aspects of Japanese institutional details will become less important. Much has happened in Japan since the timing of this conference (April 1991) and the publication of this conference volume in 1993. Attention has shifted from the Bank of Japan to the reluctance of the Japanese authorities to make use of fiscal instruments. A follow-up NBER conference and volume could well focus on the consequences of U.S. fiscal impulses on Japanese real and financial activity, including asset price bubbles, rather than monetary policy, and on the appropriate responses and operating
294
JOURNAL OF ASIAN ECONOMICS, (5)2,1!%4
procedures on the Ministry of Finance (MOF), ratherthan the Bank of Japan. For students of the Japanese economy, the book thus contains some inkwAng, totally rigorous, but dated examples of research.
Received November 1992; Revised Decemk
1993
This book brings together six papers presented at a National Bureau of Economic Research Conference on Japanese monetary policy, in April 1991. The focus of the papers is on the modus opermdi of monetary policy: (1) are short-term interest rates the operating targets of monetary policy, (2) could monetary policy have done better with a money-supply rule, (3) what information can we obtain from the term structure about Japanese monetary policy, (4) does monetary policy have real effects? Unfortunately, the papers do not take up the volatility of asset prices, especially share market and land prices, nor do they discuss monetary coordination issues. All of the papers are rigorous, make use of state-of-the-art empirical methods, and draw clear-cut policy implications from their analysis. The book is especially useful for graduate students considering dissertation topics on monetary problems of East Asian economies, since it shows how one can put the latest tools to work in this area, and how one can combine rigorous econometric analysis with interesting, sometimes fascinating, institutional detail. The book also shows us what we can get from this type of analysis, and what questions about Japanese monetary policy remain controversial and unanswered. The major problem confronting any empirical analysis of Japanese monetary policy is parameter stability: the markets have been undergoing an evolving process of liberalization and openness during the past decade, so structural change is an intrinsic part of the econometric analysis. Thus, the researchers must look for proxy variables which capture the process of structural change, or use methods which do not require structural relationships with unchanging coefficients. At best, however, the results of the analysis capture evolving relationships. Rather than present a chapter-by-chapter summary, I will concentrate on three papers that most appeal to me, and then offer brief summaries of the remaining three. Chapter 4, ‘The Interest Rate Process and the Term Structure of Interest Rates in Japan”, by John Campbell and Assisi Hamao, is a vintage John Campbell piece. The authors show us how to blend good dynamic theory with good dynamic econometrics, Pad D. MeNdis Jownal
ofAsho
l
Gmqetown
University, Department of l?.cmomi~, Washington, DC 20057.
Esonomk8, Vol. 5, No. 51994,
pp. 291-294.
copyright 0 1994 by JAI Press, Inc. h am fw
ISSN:S$&of
291
292
JOURNAL OF A!3AN ECONOMICS, (5)2,1994
withod OV@bUdklg thenadtr with technical de&l. While the data reject expectations theories of the term structure, they show that interest rate spreads help forecast short-term interest rates, and they show there is no evidence of “excess volatility” in the returns on long-term government bonds, since the actual volatility is roughly equal to that predicted by the expectations theory. Chapter 3, “Japanese Corporate Investment and Bank of Japan Guidance of Commercial Bank Lending”, by Take0 Hoshi, David Scharfstein, and Kenneth J. Singleton, offers an assessment of the aggregate macro and distributional effects of the “window guidance”, or direct credit restrictions, exercised by the Bank of Japan in the years prior to the liberalization of the mid- 1980 s. In this chapter, the authors provide a fascinating review of recent Japanese-language articles which examined the effectiveness of such guidance. They explain why some authors consider such guidance to be ineffective: since the loan limitations are only imposed on a subset of institutions, other institutions take up the slack. However, they also review counterarguments: increased window guidance leads to a lower call rate, which induces not only more lending by banks subject to window guidance, but also larger holdings of excess reserves by both types of banks. To explore the issue of window guidance, the authors use as an indirect measure of BOJ guidance or proxy variable the proportion of loans to corporations from financial institutions that are restricted by guidance, to total loans by financial institutions. This ratio declines during periods of monetary tightening, and is relatively high or rising during periods of monetary ease. The authors then use a VAR model relating this variable to the call rate, to growth rate of the real capital stock, and the growth rate of the real capital stock, and the growth rate of inventories of corporations. They find that the proxy variable has significant effects on both capital stock and inventory growth rates, and that there is little evidence of feedback from other variables to this proxy. They conclude that changes in this variable represent Granger exogenous shocks to the stance of monetary policy. The authors examine the distribution effects of window guidance through the . analysis of panel data. They conjecture that firms which belong to keirtis~ or group affiliations are less affected by window guidance than independent firms. They find that group firms tend to invest more during the period of tight monetary policy, that their investment is less constrained by liquidity, and that the difference in the sensitivity of investment to liquidity between group and independent firms is especially large during periods of tight monetary policy. Chapter 6, “An Aggregate Demand-Aggregate Supply Analysis of Japauese Monetary Policy, 1973-1990” by Kenneth D. West, develops an unrestricted re&ced-form vector-autoregressive (vAR) representation from a six-equation aggregate demandsupplymodel.From the reduced form, West obtains variance-decomposition estimates which show that money supply estimates do not account for a large share of the variance of any of the variables of the model, except the money supply itself. West also examines the effects of alternative money-supply rules. He fmds that actual outcomes and hypothetical outcomes form a constant monetary growth rule are
Book Reviezu
293
quite similar. west is careful not to interpret this result as evidence thatthe Bankof Japanfollowed a monetarist doctrine in practice, if not in announced policy.Rather, Westraises the issue that if the Bank of Japan was pursuing an activist stabilization policy, such policy had little effect on the economy. Three other papers examine the procedures and real effects of Japanese monetary policy. Chapter 1, “A Comparative Perspective on Japanese Monetary Policy: Shortrun Monetary Control and the Transmission Mechanism”, by Kazuo Ueda, argues that the policy target of the Bank of Japan has been the call rate, at least in its daily operations. While monetary aggregates and loans also predict real variables fairly well, Ueda argues that the call rate and bank lending Granger-cause other monetary indicators. Chapter 2, “Market Operations in Japan: Theory and Practice”, by Kunio Okina, qualifies the results of Ueda’s analysis. Okina argues that interest rate determination has an endogenous element. One should see the process of pursing monetary policy is a dialogue between the Bank of Japan and market participants. Finally, Chapter 5, “Monetary Policy and the Real Economy in Japan”, by Hiroshi Yoshikawa, analyses the impulse-response functions derived by a five-equation model of Japan, with interest-rate smoothing. In contrast to West’s analysis, Yoshikawa’s results lead him to reject both old and new monetarist models of the business cycle. The focus of this NBER conference volume is on Japanese monetary policy. During the 1980’s Japan’s trade surplus surged, in tandem with US. fiscal deficits and the quantity of U.S. external debt. While the book takes up the effectiveness of Japanese monetary policy operating procedures on the real sector of the economy, it is hard for readers to pay close attention to the arguments, pro and con, relating to this issue. We know that changes in bonds, especially the massive changes that took place in the 1980’s, in contrast to changes in money, lead to permanent changes in the relative prices of assets, and thus to changes in the lending opportunities in international financial markets. The international transmission effects of U.S. fiscal policy, and the ensuing wealth effects these policies caused in Japanese capital markets, appear to be far more interesting research issues, than the neutral or non-neutral effects of operating procedures of the Bank of Japan. While different chapters of the book offer contrasting results on monetary policy neutrality, one wonders if this issue merits further care. In conclusion, the book offers interesting insights into the operating procedures of the Bank of Japan during the process of liberalization of its financial markets, and offers researchers examples of how good econometric techniques can be applied to financial markets in such transition processes. However, as these markets become more open and internationalized, the peculiar aspects of Japanese institutional details will become less important. Much has happened in Japan since the timing of this conference (April 1991) and the publication of this conference volume in 1993. Attention has shifted from the Bank of Japan to the reluctance of the Japanese authorities to make use of fiscal instruments. A follow-up NBER conference and volume could well focus on the consequences of U.S. fiscal impulses on Japanese real and financial activity, including asset price bubbles, rather than monetary policy, and on the appropriate responses and operating
294
JOURNAL OF ASIAN ECONOMICS, (5)2,1!%4
procedures on the Ministry of Finance (MOF), ratherthan the Bank of Japan. For students of the Japanese economy, the book thus contains some inkwAng, totally rigorous, but dated examples of research.
Received November 1992; Revised Decemk
1993