Japan's Approach to Monetary Policy
Olivei, Giovanni P., New England Economic Review
The goal of monetary policy as conducted by the Bank of Japan is to contribute to the sound development of the national economy through the pursuit of price stability. The objective of price stability, however, is not precisely defined as it has been for other central banks. Following the implementation of the new Bank of Japan Law in 1998, the monetary policy framework is characterized by central bank independence, the primacy of the price stability objective, instrument independence, and policy decisions made by a monetary policy committee with regular meetings and published minutes. At its meetings, the monetary policy committee discusses the economic and financial situation and then decides matters relating to monetary policy, including the following: the guideline for money market operations; the official discount rate; reserve requirements ratios; the Bank's view of economic and financial developments; and the types, terms, and conditions of bills and bonds used in money market operations.
Bank of Japan's Main Monetary Policy Instruments
In recent years, the Bank of Japan has targeted a specific level of the uncollateralized overnight call rate, with open market operations aimed at increasing the provision of funds when the overnight call rate is above target, and at decreasing the provision of funds when the overnight call rate is below target. The funds whose provision the Bank modifies in its day-to-day open market operations are the current account balances that private financial institutions hold at the central bank. These balances are made for the most part by the legal reserve requirements of depository institutions, and for the rest by the working balances of both depository and nondepository institutions. (1)
The practice of influencing the price of liquidity supplied through open market operations reflects the central role that discretionary operations now play in the management of liquidity. Market operations are geared to balancing the market for current account balances as a whole, and financial institutions are not expected to rely on standing facilities. Since mid-1995, the Bank of Japan has steered the overnight rate below the discount rate, thus rendering the discount window ineffective as a tool for active liquidity management.
While under ordinary, circumstances the Bank of Japan targets the overnight call rate, in March 2001 the Bank enacted new procedures for market operations that will stay in place until the deflationary pressures subside. Under the new procedures, the Bank sets a target for the outstanding balance of current accounts. The target for the outstanding balances held at the Bank is currently set with the goal of driving the overnight call rate to around zero. (2) However, by setting a reserve target, the Bank intends to allow, up to a point, fluctuations in the overnight call rate. The concomitant introduction of a Lombard facility provides a ceiling for the overnight call rate and limits its range of fluctuation.
Until mid-1995, the Bank of Japan employed the discount window as a tool for active liquidity management. The amount and maturity of credits granted through the window were entirely discretionary, and the Bank could also recall loans at will. However, the window became ineffective when the Bank steered the overnight call rate below the discount rate, and in January 1996 the Bank announced it would no longer use discount credit as part of its regular liquidity management operations.
With the introduction of the new Lombard facility, the Bank of Japan suspended the discounting of commercial bills. The Lombard facility is fully collateralized and is activated at the request of the counterparties. The interest rate charged is the posted official discount rate (now called the "basic loan rate"). A penalty, however, is levied to counterparties that use the facility longer than five days per month on a cumulative business-day basis. …