The Bank Of Japan

The Bank of Japan
With the passing of the Bank of Japan Act in 1882, the Bank of Japan (BOJ) was officially established as the nation’s first central bank and is one of the world’s oldest central banks. The bank’s headquarters are located in Tokyo, however the face of the bank is considered to be the Osaka branch. In the midst of World War II, the Bank of Japan Law (the Law of 1942) replaced the aforementioned act and set new guidelines for the bank. Although several changes were subsequently made to the Bank of Japan Law (many by Allied occupiers), it was only heavily revised in 1997 due to the changes of the global economy. The new law emphasized transparency and increased independence of the bank from the government.

Previously, the lack of independence from the Government was one of the marked differences between the Bank of Japan and other central banks like the Federal Reserve and the European Central Bank. In Japan, the government does have an effect on policy and the Governor of the bank must work together with the Prime Minister in order to be effective, which will ensure that the nation’s monetary policy will fit with the government’s economic policy. While the new legislation provided some separation between the two institutions, they are still linked. For instance, the Bank of Japan’s budget must still be approved by the government. Regardless of the new laws, in order for the bank to achieve its goals, collaboration between the Governor of the bank and the Prime Minister is required. Failure to do so could lead to an ineffective administration, such as the one held by previous Governor Masaru Hayami, who often bickered with the Prime Minister.

The Bank of Japan’s decision making body is known as the Policy Board, which consists of the governor, two deputy governors and six other members. All nine members are appointed by the Cabinet, Japan’s executive branch, and approved by the Diet (the legislature) for a term of five years. The Policy Board meets frequently, but two meetings per month are solely dedicated to discussing monetary policy. Decisions on monetary policy and on how to achieve the bank’s goals are made through a majority vote of the Policy Board.

The BOJ’s first mission is to maintain price stability. In other words the goal is to create a situation where there is neither inflation nor deflation. In order to achieve this, the bank conducts monetary policy by buying or selling securities on the open market and altering the interest rate. Recently, Japan was suffering from deflation and was maintaining a Zero Interest Rate Policy (“ZIRP”) in order to spur the economy, which is still in effect today. Although ZIRP is a valid method to restore economic health, once implemented it severely hampers the BOJ’s future monetary policy efforts because it can not lower the interest rate from 0%.

The second mission of the BOJ is to ensure the stability of the financial system and to develop the economy. In order to achieve this, the bank engages in the following activities: issuing banknotes, providing settlement services, international activities, government securities operations, and compiling economic data.

How the Bank of Japan Affects the Foreign Exchange Market
The Japanese economy is very dependent on importing and exporting goods and services. Nearly all of their natural resources, such as oil are imported and a large portion of their businesses’ products/services are exported. As a result, the Bank of Japan used to peg the Yen to the U.S. Dollar at a fixed rate in order to remain competitive in their exporting operations. Eventually, they allowed the Yen to float, but are still known to occasionally intervene in the Foreign Exchange Market and artificially manipulate the price of the USD/JPY. In the past, traders have taken advantage of their intervention and reaped tremendous profits, so it is important to follow the press releases of the BOJ for any hint of intervention.

Also, the BOJ’s interest rate decisions have a profound effect on the Yen’s exchange rate. For example, if the BOJ decides to raise the interest rate, then returns on Yen assets will appear more favorable to investors and the Yen will appreciate in value. This will create a situation where imports are cheaper for Japanese citizens and their exports become more expensive to the rest of the world. Currently with interest rates at 0%, Japanese investors are some of the largest investors in foreign securities (in a recent quarter they purchased $84 billion worth), but if returns in Japan were to increase, then investors will be more inclined to sell their foreign assets and purchase domestic ones. On the other hand, if the BOJ chooses to lower the interest rate, then Yen assets will not be as appealing to investors and the Yen will depreciate in value. This scenario causes imports to be more expensive for Japanese citizens, but their exports become more appealing to other nations. Currently, this scenario is impossible because interest rates are at 0%.

Current Governor: Toshihiko Fukui
Toshihiko Fukui’s road to leadership has been bumpy, but on March 20, 2003 he took over the reins of the Bank of Japan from Masaru Hayami. Born in the commercial city of Osaka to an umbrella exporter, Mr. Fukui followed the ‘traditional’ path early in his career. He received a prestigious law degree from the University of Tokyo and eventually joined the Bank in 1958. He served in many different positions before being appointed a deputy governor in 1994. In fact, he was so successful that he was nicknamed ‘the prince’, implying that he was the heir to the throne of the bank. Unfortunately, in 1998 a scandal involving one of his underlings at the bank surfaced and he was forced to resign as a sign of taking responsibility even though he was not directly involved. After leaving the bank, he became the Vice Chairman of the Keizai Doyukai (the Japan Association of Corporate Executives) and served on the Board of Directors of several large companies. Just five years after leaving the bank he returned and was anointed the leader of one of the world’s largest economies.

Despite feeling elated about his new position, Mr. Fukui inherited an extremely difficult position. One reason it was so challenging was that the reputation of the Bank was tarnished due to the previous administrations’ blunders. In the late 1980’s the bank tightened rates too late and were unable to prevent the ensuing crash in the stock and real estate market. Then in the 1990’s, the BOJ was criticized for not doing enough to revive a slumping economy. The most recent blunder occurred in 2000 when the Bank believed that the economy had recovered and it chose to raise interest rates. At the time many politicians and economists urged the Bank to reconsider this move and eventually it gave in, but only after the economy had resumed its decline.

Another reason that becoming Governor at this time was very difficult was the poor state of the Japanese economy. The country was suffering from multiple years of deflation and both stock and land prices were extremely low. The entire country was mired in a deep recession. Normally, the response of a central bank would be to lower rates however, Japan’s interest rate was already at 0% making this impossible. Therefore, Mr. Fukui was forced to use more unconventional methods to resuscitate the economy such as flooding the nation’s banks with Yen to promote lending.

After several trying years during which he withstood criticisms from both then Federal Reserve Chairman Alan Greenspan and Federal Reserve Governor Ben Bernanke, Mr. Fukui’s methods began to yield results. Recently, Japan has had several periods of rising prices, potentially signifying the end of deflation. In March 2006 Mr. Fukui indicated that the era of ZIRP could be over and a future rate increase could be forthcoming within a year. This news sent the Yen skyrocketing, illustrating one of the tough challenges facing Mr. Fukui. Now that the economy is strengthening, he must be careful that the Yen does not appreciate too much in value otherwise the nation’s exporting business will be crippled. While Mr. Fukui has certainly proven that he can bring the bank out of the doldrums and has earned sorely needed respect for the bank, he must now prove that he can successfully guide the economy into a period of growth and maintain it.

Unfortunately, the new era did not begin as Mr. Fukui had imagined it would. Recently, news sources reported that during his time away from the bank, Mr. Fukui invested 10 million yen in a fund run by a trader accused of insider trading. This information caused the Nikkei (Japanese stock market) to fall over 600 points. Several political leaders even called for Mr. Fukui’s termination and some economic analysts wonder whether this will affect his ability to change the ZIRP. Based on his recent history, Mr. Fukui should be able to weather the storm, but whether or not he can guide the economy of Japan into an era of prosperity remains to be seen.

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