IMES DISCUSSION PAPER SERIES Monetary Policy in the 1990s: Bank of Japan's Views Summarized Based on the Archives and Other Materials Masanao Itoh, Yasuko Morita, and Mari Ohnuki Discussion Paper No. 2020-E-6 INSTITUTE FOR MONETARY AND ECONOMIC STUDIES BANK OF JAPAN 2-1-1 NIHONBASHI-HONGOKUCHO CHUO-KU, TOKYO 103-8660 JAPAN You can download this and other papers at the IMES Web site: https://www.imes.boj.or.jp Do not reprint or reproduce without permission. NOTE: IMES Discussion Paper Series is circulated in order to stimulate discussion and comments. The views expressed in Discussion Paper Series are those of authors and do not necessarily reflect those of the Bank of Japan or the Institute for Monetary and Economic Studies. IMES Discussion Paper Series 2020-E-6 March 2020 Monetary Policy in the 1990s: Bank of Japan's Views Summarized Based on the Archives and Other Materials Masanao Itoh*, Yasuko Morita**, and Mari Ohnuki*** Abstract This monographic paper summarizes views held by the Bank of Japan (hereafter BOJ or the Bank) in the 1990s regarding economic and financial conditions as well as the conduct of monetary policy, based on materials compiled during the period mainly in its Archives. The following points were confirmed in writing this paper. First, throughout the 1990s, the Bank's thinking behind the conduct of monetary policy had shifted toward emphasizing the transparency of its policy management. The basic background to this seemed to be the growing importance of dialogue with market participants, reflecting a change in the target for money market operations from official discount rate changes to the guiding of money market rates. In addition, the fact that the revised Bank of Japan Act (hereafter the Bank of Japan Act of 1997) came into effect in April 1998 under the two principles of independence and transparency accelerated the trend of attaching importance to transparency. Second, on the back of the emphasis on transparency, the Bank enhanced its communication by increasing its releases in the second half of the 1990s, particularly after the enforcement of the Bank of Japan Act of 1997. Thus, the materials, especially those referred to in the latter half of this paper, consist mainly of the Bank's releases. And third, in the 1990s, the Bank faced a critical situation in which it needed to conduct monetary policy while paying due attention to the functioning of the financial system. Therefore, this paper includes numerous references to the issues regarding the financial system, mainly the disposal of nonperforming loans. Keywords: Monetary policy conduct; Disposal of nonperforming loans; Financial system crisis; Bank of Japan Act of 1997; Zero interest rate policy JEL classification: E52, E58, N15, N25 *President, Otsuma Women's University (E-mail: [email protected]) ** Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: [email protected]) *** Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: [email protected]) The authors would like to thank referees and the BOJ staff for their helpful comments. The views expressed in this paper are those of the authors and do not necessarily reflect the official views of the BOJ. Contents I. Summary ....................................................................................................................... 1 II. Rapid Monetary Tightening (Spring 1989 through Spring 1991) .................................. 4 A. Shift to Monetary Tightening (Spring 1989 through Summer 1990) ............................. 4 1. Economic developments at home and abroad ............................................................ 4 2. Monetary policy response ......................................................................................... 6 B. Further Monetary Tightening and Continuation of Tight Monetary Policy (Summer 1990 through around May 1991) .............................................................................................. 11 1. The Gulf Crisis and economic conditions at home and abroad ................................. 11 2. Monetary tightening and its continuation after the onset of the Gulf Crisis ............. 12 III. Shift to Monetary Easing and Protracted Economic Downturn (Summer 1991 through the End of 1993) ............................................................................................................. 14 A. Shift to Monetary Easing ........................................................................................... 14 1. Global economic environment and economic conditions in major countries ............ 14 2. Economic conditions in Japan ................................................................................. 16 3. Reduction of the official discount rate and abolition of window guidance (summer through winter 1991) .................................................................................................. 17 a. Abolition of window guidance ............................................................................. 17 b. First reduction of the official discount rate (July 1991) ....................................... 18 c. Decline in market interest rates ........................................................................... 20 d. Reduction of the reserve requirement ratio .......................................................... 21 e. Second reduction of the official discount rate (November 1991) .......................... 21 f. Third reduction of the official discount rate (December 1991) ............................. 22 g. Application of the deposit insurance system ........................................................ 23 B. Continuation of Monetary Easing and Worsening of the NPL Problem (Spring 1992 through Autumn 1993).................................................................................................... 24 1. Progress in the Japan-U.S. Structural Impediments Initiative .................................. 25 2. Economic conditions in Japan ................................................................................. 26 3. Toward an unprecedentedly low level of interest rates ............................................ 28 a. Fourth reduction of the official discount rate (April 1992) ................................... 28 b. Fifth reduction of the official discount rate (July 1992) ....................................... 29 c. Sixth reduction of the official discount rate (February 1993) ............................... 30 d. Guiding market interest rates lower ..................................................................... 31 e. Seventh reduction of the official discount rate (September 1993) ........................ 32 f. Worsening of the NPL problem ............................................................................ 34 IV. Changes in Financial Conditions and Monetary Policy Response (Early 1994 through Summer 1995) ................................................................................................................ 37 A. Concerns about Economic Growth Stalling due to the Yen's Appreciation and Pressure from Global Competition ................................................................................................ 37 1. Economic conditions in major overseas economies ................................................. 37 2. Economic conditions in Japan ................................................................................. 38 B. Changes in Financial Conditions and Policy Response ............................................... 42 1. Changes in financial conditions .............................................................................. 42 a. Progress in financial deregulation ........................................................................ 42 b. NPL problem and the Bank's response ................................................................. 43 c. Disclosure of the amount of NPLs ....................................................................... 47 2. Shift in monetary policy tools ................................................................................. 48 a. Encouraging a decline in short-term market interest rates (March 1995) .............. 48 b. Eighth reduction of the official discount rate (April 1995) .................................. 50 c. Encouraging a decline in short-term market interest rates (July 1995) ................. 51 d. Ninth reduction of the official discount rate (September 1995) ............................ 51 e. Change in monetary policy tools .......................................................................... 52 V. Materialization of a Financial System Crisis in Japan (Autumn 1995 through Summer 1998) .............................................................................................................................. 54 A. Beginning of Global Financial Crises (Autumn 1995 through the End of 1996) ......... 54 1. Economic conditions in major overseas economies121 ............................................. 54 2. Economic conditions in Japan ................................................................................. 55 3. The jusen problem and six financial system related laws ........................................ 56 4. Monetary policy conduct from autumn 1995 through 1996 ..................................... 59 B. Outbreak of the Asian Financial Crisis and a Financial System Crisis in Japan (1997) 60 1. Outbreak of the Asian Financial Crisis