Oil Crisis
February 2003
Economics 272
Prof. Smitka
Policy Tools
• Japanese banking differs (in the post-WWII period) from the US in key aspects– Banks that are national in scope (11 "city" banks a
nd 3 special-purpose banks)– Lack of government bond market
• "Dodge Plan" of 1949 restricted deficit financing
• Interest rate regulation– As in the US, fixed deposit interest rates– Also (on paper) regulated lending rates
• Unregulated interbank "call" rate, cf. Fed Funds
Households
Postal Savings
FILP
RegionalBanks
CityBanks
LifeInsurance
Short-term Long-term
InterbankMarket
CorporationsInfrastructureother Gov't Lending
Financial institutions
• City banks at core– typically net borrowers in the interbank marke
t• Regional banks, credit associations, etc
– Far fewer financial institutions than in the US• Government policy "banks" (lending only)
– Financed with FILP funds• Postal savings system (deposits only)
– Supplied FILP funds
Corporate Finances
• Corporate finance was:– Own funds (retained earnings)– Bank borrowings– No bond market, little use of equities after 1
963• Personal savings was:
– Banks (including postals savings)– Also life insurance (higher returns)– Real assets (real estate)
Flow of funds
• Hence funds flowed from:– Households– To firms– Via banks
• Hence funds flowed from:– Regional banks (with lots of branches) to– City banks (fewer branches, commercial focus)
• Except when BOJ imposed tight money
Monetary Policy Tools
• Hence "open market" operations were not possible.– No gov't bonds to buy / sell!– Note this changed from the mid-1980s; Japan toda
y has the ability to trade bonds
• Discount window lending– Reserves were borrowed from BOJ– BOJ could ask city banks to adjust credit creation
• Discount rate as visible signal
Why Monetary Policy?
• Obvious:– Business cycle
• Tighten money conditions when inflation threatens
• Make money "easy" in recessionary periods
– Financial stability• Intervene in times of crisis [?? no macro
impact]
Why monetary policy?
• Non-obvious– Foreign exchange constraints
• Fixed exchange rate after April 1949– Dodge Plan set at ¥360 per US$
• Japan was not credit-worthy: borrowing not an option, assets (US$ foreign reserves) minimal– In boom trade balance X-M = X-mY turns negative,
except through chance export boom– BOJ must slow to cut growth (Y) and thus imports
Sum
• A pronounced business cycle– Tightening when balance of payments moved
into the red– Tightening when inflation rose
• But high-growth environment– Otherwise, investment very high– BOJ expanded money supply through discount
window to support
Real GDP Growth
-3.0%
0.0%
3.0%
6.0%
9.0%
12.0%
15.0%
1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
GDP growth rates
Business Cycle Details
• When trade deficit rose– Either too fast domestic growth, or slow
exports (US recession)
• Money growth was tightened• GDP growth slowed• Import growth slowed / imports fell• Money growth allowed to rise again
Implication
• Japanese growth in the 1960s was not "Keynesian"– Cycles not driven by whims of investors and c
onsequent swings of invesment and (through the multiplier) GDP
– Instead, BOJ deliberately caused slowdowns• And, implicitly, allowed speedups
• As per the following chart:
Inflation and Business Cycle
• In effect, the economy tended to overheat, which showed up first in imports and a trade deficit
• Poor investor sentiment (an exogenous recession) were not issues– the BOJ "caused" all the recessions
• But inflation - in the CPI - was high by US standards– Average was about 6% in the 1960s– BOJ reacted to an uptick in 1970
No issue here!!
Trade Data
• As can be seen here, no problem with imports in 1969
• The second chart traces movements in the discount rate as an indicator of shifts in monetary policy
Prime Minister Kakuei Tanaka, 1972
田中角栄• 列島改造計画 Plan to Rebuild the Japanese Archipelago
– Slowdown ca. 1970 encouraged fiscal policy– Tanaka started in the construction industry, used that to rais
e campaign funds for faction / political party
• 1971 ¥/$ appreciation: end of “Bretton Woods”– huge inflow of dollars, bought to lessen forex shift but booste
d money supply / lowered interest rates
• Sum: stimulative MP, FP– Double-digit inflation by 1973
Oil Crisis
• October 6, 1973 Yom Kippur War– OPEC already more active– Boom not just in Japan but also US, Europe
• I worked overtime, 7 days / week, at UAW wages …• Demand made cartel discipline moot
– Oil prices quadrupled• Japan imported 99+% of oil• Huge boost in inflation
• Inflation jumped to 25%– Panic buying: shoppers trampled to death buying TP
Bank of Japan reactionsee also next charts on forex rate, discount rate and call
rate
April 1973 4.5% --> 5%
May 1973 5.5%
July 1973 6%
August 1973 7%
December 1973 9%
April 1975 Began lowering
Foreign Exchange Rate
260
270
280
290
300
310
320
330
340
350
360
1970.011970.041970.071970.101971.011971.041971.071971.101972.011972.041972.071972.101973.011973.041973.071973.101974.011974.041974.071974.101975.011975.041975.071975.10
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
11.00%
12.00%
13.00%
14.00%
Yen per dollar Call Rate Discount Rate
Analytic issues
• Time lags– Recognition
– Implementation
– Impact
• Time consistency– Short-run versus long-run
• Structural issues– Institutional change renders historical relationships (model
parameters) misleading
Monetarist models
• MP = ? … what should be goals?• MV PY … an identity: true by definition
– M is money stock– V is velocity, ability of a given amount of
money to support economic activity– P is price level, Y real GDP
• So PY is nominal GDP
• Can this framework be used?
MV PY
• IF velocity “V” is stable• AND the link between nominal and real
GDP is predictable• THEN can tie changes in money supply to
changes in “P” – that is, inflation• But in fact
– V is noisy and shifts with institutional change– PY is not easy to decompose
Sample arithmetic
• MV PY…to use, add growth rates– M plus 5%
• V ±2% since volatile / large error component– Then PY can range from +7% to +3%
• Real Y avg +2% but can fall as much as -1%– [increase can be more short-run, coming out of recession]
– So P can range from:• 7% - (-1%) = 8%• 3% - 2% = 1%
• Monetarist framework offers little insight under “normal” growth rates of US and post-1973 Japan
Sample arithmentic #2
• M = +25%
• V ±2% as before– Then PY can range from 27% to 22%– Even with real Y = +5% inflation is high– But oil crisis ---> Y = -2% [or worse!]
• So inflation 24% ≈ 29%
• High “M” growth is indicative of problems
Money Supply
0
100,000
200,000
300,000
400,000
500,000
600,000
1969.011969.071970.011970.071971.011971.071972.011972.071973.011973.071974.011974.071975.011975.071976.011976.071977.01
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
M1 Currency Deposits M1 Growth
Other aspects
• FP side effects– Implications of lifetime consumption model
• MP side effects– Do you really want low investment to persis
t?– Are big swings in forex rates desirable?
• International side effects– How to respond to exogenous forex shifts?
Queries
• What happens to "V" if the BOJ boosts the money supply but no one wants to borrow?
• What should the BOJ do when the source of inflation:– is a negative supply-side shock?– is a positive demand-side shock?
• Should the BOJ ignore the international side of the economy, post-1971 [yen not fixed]?– See chart on forex, esp post-1985 movements
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
1983/10/221984/4/22
1984/10/221985/4/22
1985/10/221986/4/22
1986/10/221987/4/22
1987/10/221988/4/22
1988/10/221989/4/22
1989/10/221990/4/22
1990/10/221991/4/22
1991/10/221992/4/22
1992/10/221993/4/22
1993/10/221994/4/22
1994/10/221995/4/22
1995/10/221996/4/22
1996/10/221997/4/22
1997/10/221998/4/22
1998/10/221999/4/22
1999/10/222000/4/22
2000/10/22
BOJ Discount Rate Target Call Rate
Nov 1, 1986following
"Plaza Accord"
Feb 23, 1987
May 31, 1989first anti-"Bubble"
rate hike
Aug 30, 1990
Jul 1, 1991interest rates
kept high for 18months following
the "bubble's" peak
Sept 8, 19950.5%
discount rate!!
Feb 12, 1999"Zero InterestRate Policy"commences
Christmas 1989rate hike
– "bubble" peaks –