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 –