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Money, finance, and macroeconomic performance in Japan
JOURNAL
OF COMPARATIVE
ECONOMICS
12, 150- 154 ( 1988)
YOSHIO SUZUKI, Money, Finance, and Macroeconomic Perfhrmance in Japan.
New Haven, CT: Yale Univ. Press, 1986. xvii + 218 pp., index. No price. The book, Money, Finance, and Macroeconomic Performance in Japan, by Yoshio Suzuki is basically a continuation of a story which started with the author’s preceding book, Money and Banking in Contemporary Japan (New Haven, CT: Yale Univ. Press, 1980, Japanese edition 1974). The new book is divided into two parts. The first part discusses in four chapters the evolution of the financial system in Japan and the second part analyzes in another four chapters the relation between money and macroeconomic performance. Since 1974, Japan experienced enormous changes in its economic structure and its financial conditions. The two phenomena of “overloan”’ and skewness of funding, which were characteristic conditions of the Japanese financial system since the end of World War II, disappeared after 1974. As a result, the equally predominant phenomenon of “overborrowing”* abated and the nature of skewness of funding and overloan changed after 1974. The main objective of this new book is to familiarize foreign readers with the more recent trends within the Japanese financial system and economy. The first chapter provides a historical background for the financial system in Japan and describes the new forces that are bringing about important changes. These changes are documented in the second chapter with statistical ’ The term “overloan” is defined strictly asthe condition when central bank money lessborrowed funds is negative. A publication of the Japanese Kinyu Seido Chosakai (Monetary System Research Council) entitled “The Correction of Overloan,” in its recommendation of May 9, 1963, defined overloan as “the phenomenon whereby banks overlending depends primarily on Bank of Japan loans.” Since in this case, “overlending” is defined as “net bank reserves (equal vault cash plus deposits with the Bank of Japan minus borrowing from the Bank of Japan, or vault cash plus deposits with the Bank of Japan minus external liabilities) being negative,” this conforms to the above stricter definition suggested by Suzuki in 1974. The overloan is considered as a unique Japanese monetary phenomenon among industrial countries. It prevailed in Japan after the end of the war, but disappeared after the recent interest rate deregulation and the elimination of the artificial low interest rate policy in Japan. 2 The term “overborrowing” refers to the financing of the corporate sector and indicates a condition of heavy dependence on bank borrowing. The Japanese bank loan ratio was high, primarily because internal financing of the Japanese companies was low, and second, because the proportion of external financing from the issue of securities was also low. The first phenomenon is related to Japan’s export-oriented, investment-led rapid growth, and the second to the underdevelopment of the capital market (or the preference for indirect financing), which was in turn related to the low interest rate policy and policy of nonintemationahzation. 0147-5967188 $3.00 Copyright 0 1988 by Academic Press, Inc. All rights of reproduction in any form rmerved.
150
BOOK REVIEWS
151
analyses. Evidence indicates that (a) financial assets held by the private nonfinancial sector as ratios of GNP have increased gradually since the second half of the 1970s; (b) in the midst of this speedup in the acceleration of financial assets, in relative terms, only holdings of currency and deposit money assets diminished; and (c) there have been major changes in the composition of investment accounts3 Direct financing increased in relative importance while indirect financing decreased.4 This was a result of mainly the two-tier interest rate structure with regulated rates and free market rates, and the irrational term structure of regulated rates. The resulting decline in the share of deposit banks in the total flow of funds is the most important force behind the current financial deregulation and reform. As it is explained in Chapter 3, the current financial deregulation and reform is one among a variety of factors behind the recent trend toward financial innovation by financial intermediaries. Other factors are (a) the high, variable, and unpredictable inflation and interest rates; (b) changes in the international environment and increasing integration of domestic and international financial markets; (c)the increase in government deficits; and (d) the rapid development of technology in the financial sector. During the period of financial innovations, two new financial instruments, the repurchase agreements and certificates of deposit, have developed new financial markets of their own. Instead of competing with or eroding the long-existing interbank money market, they developed a previously nonexisting open money market. Among the retail banking innovations, the cash-economizing services are most important. Direct deposit of salaries and direct deduction of bills for telephone, electricity, and water, as well as Social Security contributions and taxes, have expanded substantially in the past decade. Since 1980, many financial institutions in Japan have linked their on-line systems to those of others, forming interbank systems for drawing cash from deposits of other institutions. Bank customers in Japan are free to draw cash from cash dispensers and automatic teller machines of other banks belonging to the same system. With the Information Network System (INS) under construction by the Nippon Telegraph and Telephone Public Corporation, “firm banking” and “home banking” are another set of financial innovations in progress. Another innovation introduced in 1972 was the establishment of deposit combined accounts. Settlements can now be made with even zero balance in demand deposit accounts using time deposits and loan trusts as collateral. As a result of these innovations in retail banking services, households 3In particular, there have been major changesin the compositionof broaderfinancialassets excludingcash and deposit money and in the underlying channels of these flows of funds. 4 Among financial institutions engaged in indirect financing, the market share of private deposit banks declined and that of private nondeposit banks and public sector financial intermediaries increased.
152
BOOK
REVIEWS
theoretically can live without cash or demand deposit balances, forcing the velocities of Ml and M2 + CDs to change and money demand aggregates to shift. Another set of innovations is making the distinction between banks and securities companies less clear. Since 1983, banks are permitted to sell newly issued medium-term and long-term government bonds over the counter, and since 1984 to sell outstanding government bonds. At the same time, securities companies are in fact offering a type of demand deposit account through their medium-term government bond funds, in the sense that customers are free to draw funds in small amounts from these accounts after 1 month on deposit. In addition, securities firms can lend within limits on a case-by-case basis with government bonds as collateral. The more important implications of these financial innovations for monetary policy concern the definition and measurement of monetary aggregates, the transmission mechanism of monetary policy, and the ability to regulate and stabilize the financial markets. For example, innovation in transaction accounts with high interest rates gives rise to the problem of whether to include them in Ml or in M2-a problem never faced before innovation in investment accounts gave rise to the problem of whether to include such accounts in the definition of money at all. At the same time, the transmission mechanism of monetary policy which was based on credit rationing is fading out. For instance, the traditional mechanism relied on the rigidity of lending rates and of interest rates on newly issued bonds. As these rates become more flexible, the credit rationing mechanism will vanish. Similarly, disintermediation depends on the rigidity of regulated interest rates. Therefore, if these rates are adjusted more frequently or are completely liberalized, this mechanism will vanish as well. Thus, as financial innovation and interest rate deregulation advance, only the effect of interest rates on private spending will remain. All these changes have important implications for monetary policy. The problems associated with the effectiveness of monetary policy in Japan are discussed more explicitly in Chapter 4. In this chapter, the transmission channels of monetary policy are analyzed more explicitly and the relationship between the pattern of the financial system and the available set of financial assets is described. The second part of the book, “Money and Macroeconomic Performance,” starts with Chapter 5 which presents the inflation-related policy issues in postwar Japan, placing special emphasis on the last decade. Japan has been one of the few industrialized countries which have managed to maintain reasonable price stability during the worldwide inflationary pressures of the oil crises. Although inflation in Japan reached a high of 24.4% in 1974 uust after the first oil crisis), in 1980, following the second oil crisis, it peaked at only 8.0%. After the first oil crisis, with its high inflation and simultaneous deep recession, it became obvious that no long-run tradeoff existed between prices and
BOOK
REVIEWS
153
output. The result was a national consensus that introduced a stricter surveillance and control over the money stock as an intermediate target, and an attempt to deregulate interest rates as far as feasible so as to enable the transmission of policy effects by means of freely fluctuating interest rates. Chapter 6 presents the results of a number of econometric models which attempted to identify and quantify the relationship among such macroeconomic variables as the money stock, the price level, and output in the postwar Japan. The conventional wisdom in Japan held that money was neutral.s The argument was simple. The only way in which money could have an effect on real income and prices was, according to the Keynesian doctrine, through the channel of influencing investment through interest rates. Since the interest rates in Japan were regulated and could not change, no change of the money supply of any size could ever affect aggregate demand or prices. But this conventional wisdom was disproved, of course, both by empirical and by theoretical works. The effect of money supply on nominal expenditure is not limited to the indirect effect passing through interest rates; there is also a direct effect. The rise in money could bring a rise in expenditure through a wealth effect and that could affect the price level and the rate of inflation. Chapter 7 looks at the yen under the floating exchange rate adopted in 1973. It presents the Japanese experience of exchange market fluctuations under the floating rate system, the development of theories of exchange rate determination, and how money supply interacts with the exchange rate. It was generally believed that under the floating rate system, the monetary authorities of individual countries would be freed from considerations of external equilibrium and that they would find it easier to manage and control their domestic money supply and interest rates in order to achieve domestic price and output stability or other domestic goals. Although under the floating rates the international transmission of inflation was halted, monetary policy cannot ignore the medium-term movements of the balance of payments and concentrate exclusively on internal equilibrium considerations. In addition to that, when a differential of real interest rates between nations occurs, the pressure for international capital flows mounts, with exchange rate affects. As a result, it proved to be inappropriate for monetary authorities either to ignore the movements of the exchange market or to determine the money supply independently of the exchange rate. Chapter 8 deals with monetary policy implementation issues and explains the reasons which dictated the recent movement of intermediate objectives from interest rates to money supply. It compares the method of targeting in Japan with that in the U.S. and in other European nations, and discusses the issues of money supply controllability and the choice of interbank interest 5 The classical statement of this doctrine is given in Osamu Shimomura’s Nihon Keizai Wa Suru, Koobundoo (the Japanese Economy Grows) (1963, Chap. 2).
Seichoo
BOOK REVIEWS
154
rates as operating variables. In Japan the call rate was originally used as an operating variable whereas today the bill rate is most important. The author concludes that Japan has been less monetarist in rhetoric than has either the U.S. or Great Britain, but has been far more monetarist in practice. Money in Japan affects all important macroeconomic variables; it therefore is not neutral, and its controllability has been successful and manageable at least during the last decade. I found this an informative and interesting book. Its strong suits clearly are the discussion of institutional features of Japan’s financial system and the evaluation of Japanese stabilization policy. The chapter on econometric estimates was less compelling. Many of these models in the past have been misspecified and/or based on faulty theoretical reasoning. Nevertheless, for economists, businessmen, and macro policy-makers not intimately acquainted with Japan’s financial and macroeconomic structure and policies, this is a book worth reading. RYUZO SATO New New
York University York, New York
10006
OF COMPARATIVE
ECONOMICS
12, 150- 154 ( 1988)
YOSHIO SUZUKI, Money, Finance, and Macroeconomic Perfhrmance in Japan.
New Haven, CT: Yale Univ. Press, 1986. xvii + 218 pp., index. No price. The book, Money, Finance, and Macroeconomic Performance in Japan, by Yoshio Suzuki is basically a continuation of a story which started with the author’s preceding book, Money and Banking in Contemporary Japan (New Haven, CT: Yale Univ. Press, 1980, Japanese edition 1974). The new book is divided into two parts. The first part discusses in four chapters the evolution of the financial system in Japan and the second part analyzes in another four chapters the relation between money and macroeconomic performance. Since 1974, Japan experienced enormous changes in its economic structure and its financial conditions. The two phenomena of “overloan”’ and skewness of funding, which were characteristic conditions of the Japanese financial system since the end of World War II, disappeared after 1974. As a result, the equally predominant phenomenon of “overborrowing”* abated and the nature of skewness of funding and overloan changed after 1974. The main objective of this new book is to familiarize foreign readers with the more recent trends within the Japanese financial system and economy. The first chapter provides a historical background for the financial system in Japan and describes the new forces that are bringing about important changes. These changes are documented in the second chapter with statistical ’ The term “overloan” is defined strictly asthe condition when central bank money lessborrowed funds is negative. A publication of the Japanese Kinyu Seido Chosakai (Monetary System Research Council) entitled “The Correction of Overloan,” in its recommendation of May 9, 1963, defined overloan as “the phenomenon whereby banks overlending depends primarily on Bank of Japan loans.” Since in this case, “overlending” is defined as “net bank reserves (equal vault cash plus deposits with the Bank of Japan minus borrowing from the Bank of Japan, or vault cash plus deposits with the Bank of Japan minus external liabilities) being negative,” this conforms to the above stricter definition suggested by Suzuki in 1974. The overloan is considered as a unique Japanese monetary phenomenon among industrial countries. It prevailed in Japan after the end of the war, but disappeared after the recent interest rate deregulation and the elimination of the artificial low interest rate policy in Japan. 2 The term “overborrowing” refers to the financing of the corporate sector and indicates a condition of heavy dependence on bank borrowing. The Japanese bank loan ratio was high, primarily because internal financing of the Japanese companies was low, and second, because the proportion of external financing from the issue of securities was also low. The first phenomenon is related to Japan’s export-oriented, investment-led rapid growth, and the second to the underdevelopment of the capital market (or the preference for indirect financing), which was in turn related to the low interest rate policy and policy of nonintemationahzation. 0147-5967188 $3.00 Copyright 0 1988 by Academic Press, Inc. All rights of reproduction in any form rmerved.
150
BOOK REVIEWS
151
analyses. Evidence indicates that (a) financial assets held by the private nonfinancial sector as ratios of GNP have increased gradually since the second half of the 1970s; (b) in the midst of this speedup in the acceleration of financial assets, in relative terms, only holdings of currency and deposit money assets diminished; and (c) there have been major changes in the composition of investment accounts3 Direct financing increased in relative importance while indirect financing decreased.4 This was a result of mainly the two-tier interest rate structure with regulated rates and free market rates, and the irrational term structure of regulated rates. The resulting decline in the share of deposit banks in the total flow of funds is the most important force behind the current financial deregulation and reform. As it is explained in Chapter 3, the current financial deregulation and reform is one among a variety of factors behind the recent trend toward financial innovation by financial intermediaries. Other factors are (a) the high, variable, and unpredictable inflation and interest rates; (b) changes in the international environment and increasing integration of domestic and international financial markets; (c)the increase in government deficits; and (d) the rapid development of technology in the financial sector. During the period of financial innovations, two new financial instruments, the repurchase agreements and certificates of deposit, have developed new financial markets of their own. Instead of competing with or eroding the long-existing interbank money market, they developed a previously nonexisting open money market. Among the retail banking innovations, the cash-economizing services are most important. Direct deposit of salaries and direct deduction of bills for telephone, electricity, and water, as well as Social Security contributions and taxes, have expanded substantially in the past decade. Since 1980, many financial institutions in Japan have linked their on-line systems to those of others, forming interbank systems for drawing cash from deposits of other institutions. Bank customers in Japan are free to draw cash from cash dispensers and automatic teller machines of other banks belonging to the same system. With the Information Network System (INS) under construction by the Nippon Telegraph and Telephone Public Corporation, “firm banking” and “home banking” are another set of financial innovations in progress. Another innovation introduced in 1972 was the establishment of deposit combined accounts. Settlements can now be made with even zero balance in demand deposit accounts using time deposits and loan trusts as collateral. As a result of these innovations in retail banking services, households 3In particular, there have been major changesin the compositionof broaderfinancialassets excludingcash and deposit money and in the underlying channels of these flows of funds. 4 Among financial institutions engaged in indirect financing, the market share of private deposit banks declined and that of private nondeposit banks and public sector financial intermediaries increased.
152
BOOK
REVIEWS
theoretically can live without cash or demand deposit balances, forcing the velocities of Ml and M2 + CDs to change and money demand aggregates to shift. Another set of innovations is making the distinction between banks and securities companies less clear. Since 1983, banks are permitted to sell newly issued medium-term and long-term government bonds over the counter, and since 1984 to sell outstanding government bonds. At the same time, securities companies are in fact offering a type of demand deposit account through their medium-term government bond funds, in the sense that customers are free to draw funds in small amounts from these accounts after 1 month on deposit. In addition, securities firms can lend within limits on a case-by-case basis with government bonds as collateral. The more important implications of these financial innovations for monetary policy concern the definition and measurement of monetary aggregates, the transmission mechanism of monetary policy, and the ability to regulate and stabilize the financial markets. For example, innovation in transaction accounts with high interest rates gives rise to the problem of whether to include them in Ml or in M2-a problem never faced before innovation in investment accounts gave rise to the problem of whether to include such accounts in the definition of money at all. At the same time, the transmission mechanism of monetary policy which was based on credit rationing is fading out. For instance, the traditional mechanism relied on the rigidity of lending rates and of interest rates on newly issued bonds. As these rates become more flexible, the credit rationing mechanism will vanish. Similarly, disintermediation depends on the rigidity of regulated interest rates. Therefore, if these rates are adjusted more frequently or are completely liberalized, this mechanism will vanish as well. Thus, as financial innovation and interest rate deregulation advance, only the effect of interest rates on private spending will remain. All these changes have important implications for monetary policy. The problems associated with the effectiveness of monetary policy in Japan are discussed more explicitly in Chapter 4. In this chapter, the transmission channels of monetary policy are analyzed more explicitly and the relationship between the pattern of the financial system and the available set of financial assets is described. The second part of the book, “Money and Macroeconomic Performance,” starts with Chapter 5 which presents the inflation-related policy issues in postwar Japan, placing special emphasis on the last decade. Japan has been one of the few industrialized countries which have managed to maintain reasonable price stability during the worldwide inflationary pressures of the oil crises. Although inflation in Japan reached a high of 24.4% in 1974 uust after the first oil crisis), in 1980, following the second oil crisis, it peaked at only 8.0%. After the first oil crisis, with its high inflation and simultaneous deep recession, it became obvious that no long-run tradeoff existed between prices and
BOOK
REVIEWS
153
output. The result was a national consensus that introduced a stricter surveillance and control over the money stock as an intermediate target, and an attempt to deregulate interest rates as far as feasible so as to enable the transmission of policy effects by means of freely fluctuating interest rates. Chapter 6 presents the results of a number of econometric models which attempted to identify and quantify the relationship among such macroeconomic variables as the money stock, the price level, and output in the postwar Japan. The conventional wisdom in Japan held that money was neutral.s The argument was simple. The only way in which money could have an effect on real income and prices was, according to the Keynesian doctrine, through the channel of influencing investment through interest rates. Since the interest rates in Japan were regulated and could not change, no change of the money supply of any size could ever affect aggregate demand or prices. But this conventional wisdom was disproved, of course, both by empirical and by theoretical works. The effect of money supply on nominal expenditure is not limited to the indirect effect passing through interest rates; there is also a direct effect. The rise in money could bring a rise in expenditure through a wealth effect and that could affect the price level and the rate of inflation. Chapter 7 looks at the yen under the floating exchange rate adopted in 1973. It presents the Japanese experience of exchange market fluctuations under the floating rate system, the development of theories of exchange rate determination, and how money supply interacts with the exchange rate. It was generally believed that under the floating rate system, the monetary authorities of individual countries would be freed from considerations of external equilibrium and that they would find it easier to manage and control their domestic money supply and interest rates in order to achieve domestic price and output stability or other domestic goals. Although under the floating rates the international transmission of inflation was halted, monetary policy cannot ignore the medium-term movements of the balance of payments and concentrate exclusively on internal equilibrium considerations. In addition to that, when a differential of real interest rates between nations occurs, the pressure for international capital flows mounts, with exchange rate affects. As a result, it proved to be inappropriate for monetary authorities either to ignore the movements of the exchange market or to determine the money supply independently of the exchange rate. Chapter 8 deals with monetary policy implementation issues and explains the reasons which dictated the recent movement of intermediate objectives from interest rates to money supply. It compares the method of targeting in Japan with that in the U.S. and in other European nations, and discusses the issues of money supply controllability and the choice of interbank interest 5 The classical statement of this doctrine is given in Osamu Shimomura’s Nihon Keizai Wa Suru, Koobundoo (the Japanese Economy Grows) (1963, Chap. 2).
Seichoo
BOOK REVIEWS
154
rates as operating variables. In Japan the call rate was originally used as an operating variable whereas today the bill rate is most important. The author concludes that Japan has been less monetarist in rhetoric than has either the U.S. or Great Britain, but has been far more monetarist in practice. Money in Japan affects all important macroeconomic variables; it therefore is not neutral, and its controllability has been successful and manageable at least during the last decade. I found this an informative and interesting book. Its strong suits clearly are the discussion of institutional features of Japan’s financial system and the evaluation of Japanese stabilization policy. The chapter on econometric estimates was less compelling. Many of these models in the past have been misspecified and/or based on faulty theoretical reasoning. Nevertheless, for economists, businessmen, and macro policy-makers not intimately acquainted with Japan’s financial and macroeconomic structure and policies, this is a book worth reading. RYUZO SATO New New
York University York, New York
10006