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First, the Bank of Japan should set an operating target in terms of total bank reserves and aim at its annual growth in line with desirable growth of nominal GDP, say 5 percent, with a proviso that an unforeseen increase in demand for bank reserves will be accommodated so that nominal short-term market rates should remain close to zero (endnote). The target level should also be adjusted for foreign exchange market operations, as I shall discuss below. In the current framework of the Bank of Japan's policy setting, the role of monetary base is not clearly determined. Its role as a policy indicator should be downgraded in a situation where the general public's demand for currency, a dominant part of the monetary base, can remain volatile as weakening in the credibility of a number of financial institutions may trigger an un-anticipated shift from bank deposits to currency holdings at a time when interest rates on bank deposits are virtually zero and risks of holding currencies are fairly small (given still low crime rates in Japan). Indeed, slower growth of the monetary base this year relative to last year basically reflects some weakening in the demand for currency after the postponement of the capping of deposit protection, and does not represent a tightening of the stance of monetary policy. The monetary base should be disaggregated with its currency component used as an indicator and another component, bank reserves, as an operating target if a quantity variable is needed as an operating variable. |
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Second, the ministry of finance of the Japanese government and the Bank of Japan should jointly announce the target range of the yen exchange rate, say 150 to 160 yen per US dollar. The Japanese authorities should also make it clear that they will intervene in the foreign exchange market openly to prevent the yen rising above the 150 level. Another option would be, as argued by Lars Svensson in his NBER working paper of February this year*, pegging of the yen at 150 or 160 per dollar. In addition, the Bank of Japan should announce its intention to follow a new practice of keeping yen proceeds of foreign exchange market operations in the money market by automatically raising the targeted level of bank reserves by equivalent amounts. In his first testimony in Japanese parliament, Mr. Fukui, new governor of the Bank of Japan, reportedly said that he would accept a weaker yen to the extent it is a natural reflection of easy domestic monetary conditions. The monetary base rose by more than 30 percent in the course of 2001 and by 20 percent or more over the past year. But such huge increases in monetary base have not been associated with weaker yen. Direct exchange rate targeting was a useful device for domestic economic stabilization in member countries of the European Exchange Rate Mechanism (ERM). In the case of Japan, a mutual support mechanism would not be needed. At least in technical terms, unilateral action by the Japanese authorities to support the US dollar in the foreign exchange market, with agreement with the US authorities, would suffice. |
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Third, the government should impose a special exchange rate adjustment tax on the marginal corporate profits arising from "wind-fall" increases in incomes associated with yen weakening from the level of say 120 yen to the dollar. This special tax, designed to avoid tensions with foreign producers competing with Japanese firms, would be applied to super-competitive large companies having access to domestic and international capital markets and enjoying financial advantages relative to smaller and medium-sized companies with credit access virtually limited only to borrowings from domestic banks constrained by weak capital bases and not enjoying very low capital market borrowing costs realized by the easy stance of monetary policy. |
Fourth, the government should accelerate domestic structural
reform and further encourage competition among Japanese and foreign firms
in services and other formerly protected sectors of the Japanese economy.
Industries and firms not viable in a competitive environment even at an
exchange rate remaining within the targeted range should not be protected
by overt or covert subsidies. |
Fifth, those workers who may lose jobs as a result of their
exit from the market should receive government supports for re-training.
The programmes should be financed from revenues arising from the special
export adjustment tax mentioned above. Part of these revenues may also
have to be used for income support of those elder workers who may find
it difficult to follow re-training courses. |