Central Bank Independence in a Changing Environment

Abstract

We reconsider central bank independence and present an updated model suitable for the new economic environment. In the 1990s, the significance of the central bank’s independence was widely recognized. Economic theory justified assigning monetary policy to a conservative central bank to control inflation and a large number of central banks adopted inflation targeting supported by the idea of instrument independence. The situation has changed dramatically in the twenty-first century, as inflation has been replaced by deflation. Since the global financial crisis (GFC), government debt has mounted. Because such a situation was not fully considered in the 1990s, we must re-examine central bank independence. I believe that central bank independence is still important in the current situation. By utilizing its expertise and non-political position, a central bank can play a role in leading economic policy in the right direction. Thus, an alternative model (the constitutional model), where the central bank’s independence is situated within the constitutional structure, should be proposed. A central bank acts as a check on the government’s economic policies under the principle of separation of powers. After the GFC, central banks have become responsible for financial stability, public debt management, and monetary policy. Thus, we need to consider the degree of independence they enjoy in their operations, besides monetary policy. Finally, I stress that central banks should change their stance from passive to active independence. It seems that central banks have tended to avoid political conflicts so far. However, as an independent power within the government, a central bank is expected to be more active in checking the government’s policies. By creating sound tension, governments can frame better policies to overcome the current economic difficulties. The independence of central banks requires public understanding. In connection with this issue, Appendix A discusses the issues of democracy and populism from the perspective of the culture of central banks. Appendix B discusses the transition of the Bank of Japan law from the perspective of the historical mission of the developmental stage of the national economy.

This work was supported by JSPS KAKENHI Grant Number 15H05729.

This was originally presented at “Europe and Japan: Monetary policies in the age of uncertainty,” Bruegel-Graduate School of Economics, Kobe University Conference, October 2nd, 2017. I am grateful to the conference participants, especially Professor Tamotsu Nakamura and Professor Yoich Matsubayashi, for their comments and support. I also thank my longtime friend Mr. Hiroshi Nakaso for his suggestions and comments, especially for Appendix A. I am proud to have worked for the Bank of Japan for over 35 years while helping each other with him.

Appendices

This appendix is based on my comment in “Featured Panel - Author Meets Critics: “The Changing Politics of Central Banking” by Annelise Riles (Cornell University Press, 2018)” at the Society for the Advancement of Socio-Economics in June, 2018. I thank Professor Riles for giving me this wonderful opportunity and the chance to comment on her excellent book.

Appendix A: Culture, Democracy and Central Banking

This appendix is based on my comment in “Featured Panel - Author Meets Critics: “The Changing Politics of Central Banking” by Annelise Riles (Cornell University Press, 2018)” at the Society for the Advancement of Socio-Economics in June, 2018. I thank Professor Riles for giving me this wonderful opportunity and the chance to comment on her excellent book.

2.1.1 Introduction

Since the global financial crisis, central banks have attracted social interest, and discussions about central banks have become active in academic fields other than economics. For example, Riles (2018) offered insight into an “independent central bank” in terms of the central bank’s culture. The central bank's culture is being sought as a reasons why central bank independence is not easily accepted by society. In this appendix, we discuss the central bank’s independence with reference to the anthropology discussion.

In every country around the world, a central bank was a rather isolated presence, with its own peculiar closed-off culture. Until the second half of the 1990s, most central banks were under government control. They did not stand out in society, and consequently, their culture did not attract social attention. However, as central banks grew increasingly independent and free from government interference, they were able to make policy decisions autonomously. While at first this independence concerned only monetary policy, after the experience of the 2008 global financial crisis, central banks have come to hold greater authority, such as by being responsible for financial stability. But who controls these more powerful central banks and how? As seen in the movement to “Audit the Fed” in the United States and calls for “People’s QE (Quantitative Easing)” in Britain, there are increasing calls for democratic control of central banks and monetary policy. Will central banks be allowed to remain strongly independent under such conditions? Riles (2018) suggests that the critical eye with which central banks are viewed today reflects a type of culture gap. Independent central banks proactively provide information about policies and other matters to fulfill their accountability obligations. However, the culture gap is a deep-rooted issue concerning far more than accountability.

It would be desirable for the general public to understand central banks as strongly independent presences. A more open culture in the banks themselves might also be preferable, but these seem to me to be extremely difficult to achieve. This is because central banks originally involve some sort of undemocratic characteristics. This paper discusses deepening the public understanding of central banks by describing their undemocratic qualities.

2.1.2 What is a Central Bank?

We start by addressing the question of just what a central bank is. Central bankers think of themselves as presences that provide underlying support for markets, rather than controlling them from above.

Central banks employ monetary policy to control markets by tuning interest rates and the money supply. The source of this control is the fact that the central bank is the final provider of market liquidity as central bank credit. At times such as a financial crisis, when no one else is able to supply liquidity to the markets, the central bank is the only one that can provide it. This is why a central bank is referred to as the “lender of last resort.” As described in monopoly theory, the central bank, as the exclusive supplier of liquidity, can freely decide on both its price (interest rates) and the volume (monetary base) supplied.

However, there are limits to such control. As market guardians, central banks have a duty to respond to liquidity demands from the banking sector. While explaining complex processes will be avoided here, monetary policy is implemented through financial tuning that has both an active nature of controlling the markets by supplying liquidity and the passive nature of this requirement to respond to market demand.

Monetary policy also has its limits as macroeconomic policy. But since central banks have played major roles in resolving financial crises, expectations for central banks have increased excessively. Current macroeconomic challenges include decreased  growth   capacity, referred to as secular stagnation. The monetary policy central banks implement is a policy of controlling aggregate demand, and theoretically, it does not have the power to increase the potential for economic growth. While a recent debate has focused on monetary policy’s contribution to enhancing growth potential by increasing capital investment, theoretically, monetary policy has little effect on the supply side. The mismatch between excessive expectations for monetary policy and the power that central banks possess is one factor behind dissatisfaction in central banks.

Also, central banks are essentially a presence that provides underpinning support for the markets. Central banks are “bankers’ banks.” In a market economy, private-sector banks process settlement of payments between businesses and households, while central banks process settlement of payments between banks. Ultimately, settling payments throughout the economy as a whole is concentrated in settlement performed by the central bank. The central bank's most important responsibility is that of smoothly managing settlement throughout the economy as a whole. This relationship between the economy and the central bank can be depicted as an inverted triangle (Fig. 2.1). The inverted triangle depicts how, like water flowing downhill, settlement in the economy is concentrated in central banks through private-sector banks; it also shows how the central bank is a presence that provides underpinning support for settlement throughout the economy as a whole. A settlement system or payment system, as it is formally called, is an important societal infrastructure, providing support for markets. Its maintenance  is another important central bank responsibility. In addition to maintaining and improving payment systems, the Bank of Japan also has long established and maintained money markets such as short term bills and securities, and recently has done the same for asset-backed securities.

Traditionally, the central bank’s nature has been a passive one of serving as the unsung hero behind the scenes. The way central banks have been in the spotlight since the financial crisis is a historical aberration.

2.1.3 The Market Economy and Democracy

One problem of central banks can be a lack of affinity with society. Probably one of the factors behind this is the poor relationship between the market system and democracy. The relationship between the economy and democracy is one of the most fundamental issues in the field of political economy.

The conflict between democracy and central banks is expressed in monetary policy. William Martin, the sixth Chairman of the Federal Reserve, described the role of a central bank as to “order the punch bowl removed just when the party was really warming up.” His words express the “undemocratic” nature of a central bank as reflected in its responsibility to look toward the future and respond from a medium- to long-term perspective, as opposed to democracy, which tends to be short-sighted.

2.1.4 Central Bank Culture

For economists, one of the innovative perspectives proposed by Riles (2018) is that of focusing on culture, something normally not given much importance in economics. A central bank, which is not necessarily compatible with democracy, has its own unique culture. As in any profession, central bankers are conscious of their mission in society and consider their work to have some kind of public significance. An organization is a group whose members share a social mission; thus, the norms that develop from this relationship govern their own behavior.

The nature of a strongly independent central bank is an aristocratic one, and its norms may be likened to the concept of noblesse oblige. While at first glance such norms may seem outdated, they are important in that they have preserved the autonomy of central bank organizations until now. While private-sector business have also recently begun to stress social responsibility, the norms of central bank organizations have come to serve as important factors behind central bankers’ awareness of their social responsibilities.

Yukichi Fukuzawa is one of the representative intellectuals in the Meiji period and had a great influence on the modernization of Japan. His expression “the leader of wild geese” is cited to describe the norms of the Bank of Japan staff as central bankers. This concept was introduced at the time of the BoJ’s centennial in 1982 by Governor Haruo Maekawa, one of the most respected figures in the BoJ. It can be considered an apt description of the Bank of Japan’s role within Japanese society:

“When a flock of wild geese peck for food in wilderness, there is always one goose that stays vigilant and raises its head to watch around for signs of danger. This is the leader goose that looks after the flock” (Yukichi Fukuzawa, 1874).

This description likening the role of a central bank to a leader of wild geese is an apt expression of the strong independence of a central bank with its eye on the medium and long term.

2.1.5 Constitutions and Central Banks

If central banks are not necessarily compatible with democracy, does that mean that they also are incompatible with the constitutions that describe the overall framework of national governance? The constitutions of contemporary democratic states are based on the principles of not only democracy but also constitutionalism, as symbolized by separation of powers. In fact, the independence of central banks has a natural affinity with this concept of constitutionalism. An understanding of the central bank as a constitutional presence would strengthen understanding of the institution in society. However, this would depend on central banks proactively performing their constitutional roles.

Respect for basic human rights is at the root of constitutionalism, whose main objective is to ensure that even majority rule through democracy does not infringe upon basic human rights. The courts are a typical example of constitutionalism's separation of powers. Goodhart et al. (2017) likens the independence of central banks in individual countries to the independence of their supreme courts and notes that just as international comparison shows that the degree of Supreme Court independence varies by country, so does that of central bank independence.

2.1.6 Constitutions and Central Banks

As Riles (2018) points out, today's criticism of the central bank is due to its non-democratic culture. A harsh attack by populism could come from this point.¹⁰ As discussed before, the central bank is undemocratic in nature, and what is important is to make this point understood by society. Accountability is the most important means of communication.

At present, it appears as if accountability is misunderstood by many. For example, currently it is being argued that one desirable means of accountability is that of setting clear policy objectives in advance and then achieving them. This is important for improving policy transparency. However, it goes no further than achieving objectives, resulting in a negative effect due to a loss of flexibility in monetary policy. While it is preferable for monetary policy to be managed as much as possible in accordance with rules specified autonomously, at the same time there is also a need for flexibility to quickly adapt to changing circumstances.

In its original legal meaning, accountability refers to ex-post-facto accountability. The significance of accountability is in explaining the excuses for any failure to achieve objectives. Accountability should not place too much severe limits on policy beforehand.

If accountability is understood properly as ex-post-facto responsibility, then central banks would recover their freedom of action, having been freed from the spell of accountability. After being freed from this spell, central banks should act proactively. As a constitutional presence, the central bank is responsible for serving as a constructive check on government through proactively advising on macroeconomic policies as a whole, in addition to its traditional duties of monetary policy and financial stabilization. The results should strengthen society's understanding of a central bank as a constitutional presence beyond conventional accountability.

2.1.7 Conclusion

The democratic upsurge of populism is strengthening the tension between central banks and society. This can be seen as society’s refusal to understand the central bank’s culture as a strongly independent presence even as the authority of central banks has strengthened since the financial crisis. However, central banks have an “undemocratic” nature and are not highly compatible with democracy.

A central bank is a constitutional presence and should be understood in the context of constitutionalism rather than that of democracy. To advance such an understanding, it is essential that the meaning of the central bank as a constitutional presence be understood fully. Central banks themselves need to take advantage of this status to generate stronger track records by demonstrating their own independence. To do so, they must act as proactive checks on government as a constitutional presence, rather than merely independently managing monetary policy. This is the way the central bank really gains social understanding.

Appendix B: The Historical Development of the Bank of Japan Law: A Political Economics Analysis

2.2.1 Introduction

This appendix argues the developments of the central bank legislation in Japan from its foundation using a political economics viewpoint.¹¹ Major changes in the legislation took place twice prior to the present Bank of Japan law. These changes reflect not only economic situations but also the political developments in each era. Although the previous two laws in Japan, particularly the previous one, are known as heavily regulated by the government, it could be argued that they contributed a lot to Japan’s economic development after the World War II. By contrast, despite an increase in freedom for central bank policy making, the current law does not necessarily succeed at playing an expected role. Comparing three cases, this appendix explores the problems of the present law in the context of Japan’s political and economic reform.

The three changes in central bank law in Japan correspond to (1) the emergence of capitalism (1882), (2) the implementation of the wartime economic system (1947), and (3) the transition to low growth and globalization (1998). In other words, each reflects a major shift in the Japanese economy in modern Japanese economic history. In each case, the government reformed the economic and political system to reflect changes in the economy, and reforming the central banking system was part of this. In each period, the government’s approach to economic intervention has been different. The Bank of Japan Law of the Meiji and Showa periods was pursued in tandem with the clear political economics strategy of “developmental dictatorship.” The government was led to economic development through industrial promotion and the wartime economy. The strategy became widely rooted across the economy and allowed the economic system to change. However, in the case of the current law, although amendments were conducted in conjunction with major political governmental reform, decentralized powers were promoted in politics, and more market oriented measures ware proceeded, it cannot be said that these reforms have successfully changed Japan’s politics and economy as the reform of the central bank law has not necessarily been successful.

In the remainder of this appendix, I provide a brief description of the central bank legislation since the Meiji period, which will illustrate the problem of the amendment in the current law.

2.2.2 Period of the Former Bank of Japan Laws

The Bank of Japan was founded in 1882 (the 15th year of Meiji; hereafter, e.g., “M15”). The modern currency legislation, the Currency Act, was set in 1871 (M4) but it waited more than 10 years to establish the central bank. This is because Japan first adopted an American type of national banks system, a decentralized system of banks without a central bank. Banknotes were issued by national banks (1872, M5), but this finally ended in financial turmoil. The Bank of Japan was established to bring the currency system turmoil to an end. Central banks are typically established to procure funds for fiscal spending, as well as to act as central clearing houses for payments between banks. This was the case with the Swedish Riksbank and the Bank of England. However, there had been a previous example of a central bank being established to end currency system turmoil, as the Banque de France was founded after a long period of currency system turmoil following the French Revolution. The Bank of Japan, which was a similar case, issued its banknotes in 1885 (M18); it took three years after the bank’s foundation to settle the turmoil. In addition to issuing banknotes, the Bank of Japan operated at the heart of the Japanese banking system and contributed to the development of the Meiji-period Japanese economy by supplying credit to banks, facilitating interbank settlements, and so on.

The Meiji government’s basic strategy for economic development was to promote an industrial revolution to catch up with Western powers. In the early Meiji period, the banking system had been established to supply funds to nascent important industries such as textiles, steel, and electricity. The Bank of Japan was modeled after the National Bank of Belgium. At that time, Belgium had become independent from France and was in a phase of development similar to that of Japan.

Specialized banks, Nippon Kangyo Bank (1896, M29) and the Nippon Kogyo Bank (1897, M30) were established to supply investment funds to such industries. A doctrine of specialization was established, which came to characterize the Japanese banking system. Its basic structure lasted until the 1990s. Long-term credit banks that were built to provide funds for heavy industries, disappeared in the wake of the Japanese banking crisis in 1997–1998. In developing countries, the central bank often supplies long-term credit for investment, but the Bank of Japan was designed to provide short-term credit, similar to commercial banking. With regard to credit provision, working capital was supplied through the discounting of commercial bills.¹²

At the time of the first Bank of Japan Act (Meiji law, hereafter), the relationship between the Bank of Japan and the government could be described as one in which government intervention was more limited than it would later be under the second Bank of Japan Law (Showa law, hereafter). The government appointed a supervisor and maintained the right for general oversight over the Bank of Japan’s operations. In addition, the governor was appointed by the emperor, while the directors and auditors, after their election at shareholders meetings, had to be formally appointed by the government. Therefore, while there was government involvement, the central bank was basically organized similar to a joint-stock company under the Commercial Code in the Meiji period. The directors and auditors were elected at shareholder meetings, and bill discount rates/amounts, which constituted monetary policy, were determined after a resolution by a board that comprised the governor, deputy governor, and directors. This system was modeled after that of the National Bank of Belgium and was fairly standard for central banks in the world at the time, with the exception of countries such as Germany where the government had a high level of involvement. Although the Meiji government exercised leadership, it aimed to develop capitalism by establishing joint-stock companies like those in the advanced capitalist countries. Moreover, the central bank was probably also established not to achieve state control of the economy, but rather as a necessary tool for developinomg capitalism. As a result, it was natural that the central bank would be launched in the form of a joint-stock company.

2.2.3 Period of the Former Bank of Japan Act

The establishment of the former Bank of Japan Law in 1942 (the 17th year of Showa; hereafter, “S17”) is generally understood as having been vital for establishing a wartime financial system suited to the wartime economy. Beside the central bank law, the series of measures taken under the wartime financial system established a mechanism for prioritizing allocation of funds to industries supplying the military. The measures included enactment of temporary monetary coordination legislation in 1938 (S13), establishment of a system for ordering banks to make loans in 1940 (S15), legislation for companies supplying the military in 1943 (S18), and legislation for special measures for munitions financing in 1945 (S20).

The establishment of the former Bank of Japan Law (Showa law) coincided with the end of its business under the Meiji Act of 1882.¹³ This can be seen as marking the transition to a wartime system and a shift to total state control over the economy. However, it also met the needs of that time’s economic realities, supplying funds to increase the appetite for government bonds and expand production capacity.¹⁴ Actually, although Japan had a full-scale war-time economy in the 1940s, rapid development and fiscal expansion were seen much earlier. Even under Meiji law, while the range of bills eligible for discounting was gradually expanded, as long as “involvement with industry either directly or indirectly” (Article 12) was prohibited, it was clear that the principles of Meiji law were at odds with the changing economic system. Under Meiji law, there was no regulatory basis for the central bank to take administrative measures as a branch of the government. It became an organ of state control over the economy and, with the launch of the Financial Control Council (1942), was responsible for controlling finance, including arranging financing from private-sector banks and providing guidance.¹⁵

The Showa law of 1942 went beyond the principles of commercial banking to provide more means for supplying funds to industry. For example, it expanded the range of bills that could be discounted (Article 20). Furthermore, it included provisions for the Bank of Japan to play an active role in controlling the financial sector (Article 3), which was intended with the supply of funds to munitions industries. Later, it allowed the Bank of Japan to play an active role in Japan’s post-war economic development through interventionist policies. In addition, by expanding the scope of commercial bills and the range of securities that it could deal, the Bank of Japan became more active in achieving the national economic goal. In the currency system, the gold standard was formally abolished in favor of a managed system (Articles 29–31). The adoption of the managed currency system and a stipulation concerning providing credit to the government (Article 22) allowed wartime expenses to be covered through the indefinite monetization of fiscal funds.

In addition, a dictatorial system was adopted whereby the governor alone determined policy. In other words, the joint-stock company system was overhauled, with shareholders becoming equity investors without rights of common interest. Shareholders meetings were also scrapped. As for personnel, the governor and deputy governor were appointed by the Cabinet, while the directors were appointed by the Minister of Finance. There was also a provision that allowed the government to dismiss officers. In addition, the name of the board was changed, and it was put under the control of the governor, with the deputy governor and directors losing their voting rights. Showa law of 1942 was strongly influenced by the Reichsbank Law established by the Nazis, and it was an extreme piece of legislation for the wartime economy. During wartime, however, central banks in every country were forced to act on a wartime economic basis to a greater or lesser extent. Immediately after the war, the Bank of England was nationalized, and an accord was established in the U.S. between the Federal Reserve and the Treasury. In this way, greater control was being exerted over central banks. During this period, the war resulted in economic crises both during and after the conflict, and regulation of the economy as a whole was tightened in response. However, it needs to be borne in mind that the fact that this strengthening of regulation and government intervention that extended as far as the central-banking system could not be applied as is to economic crises in peacetime. On the other hand, attention can be paid to the fact that even as Japan moved to a wartime system and government control was strengthened, the Bank of Japan was awarded status as a private corporation, as it was deemed to be an authorized corporation.¹⁶ This means that even under the wartime system, the central bank was not regarded as being part of the government like a ministry or agency. Whatever the case, the principles of Showa law were clearly based on a statist economy.

It is important to note that the wartime control-oriented system essentially continued to function for 50 years after being absorbed into the post-war development-dictatorial system. Under the wartime financial system, a system of designated banks charged with lending to individual munitions companies was established, and this formed the prototype for the famous Japanese post-war system of main banks. Consequently the wartime system continued for many years after the war. This also showed that the changes in the wartime economic system were rational in the context of changes in the economy’s structure, namely the establishment of heavy and chemicals industries and a system of mass production. The post-war Japanese economy followed a path of rapid growth that allowed it to catch up with the advanced countries as the government pursued an industrialization strategy based on allocation funds in a controlled fashion. Furthermore, the prohibitions related to government credit were included in the post-war Public Finance Act and fixed exchange rates meant that the balance of payments ceiling effectively served as an anchor. As a result, discipline was restored as the fiscal authorities adopted a policy of balanced budgets. Meanwhile, the Bank of Japan, under what was initially a fairly regulation-oriented financial system, would be responsible for interventionist financial administration, such as arranging loans. Later, while also implementing regulatory measures such as “window guidance,” it would loosen its controlling style with regard to matters such the Bank of Japan’s supply of credit to the banking sector as the economy developed.

2.2.4 The Current Bank of Japan Law

The current Bank of Japan Law (Heisei law, hereafter) was passed in 1997 and came into force in 1998. Heisei law entrusts monetary policy to a committee called the Policy Board,¹⁷ and strips the government of the right to dismiss Board members, whose status is guaranteed. Through provisions such as these, independence concerning the decision of monetary policy is enhanced. It also strips the government of general supervisory power (the right to give orders concerning any operation), which follows global standards concerning central-bank independence, particularly with regard to monetary-policy decision. The committee system was introduced much earlier under the influence of the U.S. as part of the post-war administrative reforms. Committees such as the Statistics Commission (1946) and the Education Commission (1948) were organized, and within the Bank of Japan, the Policy Board was established in 1949 (S24). However, because the Ministry of Finance retained wide-ranging supervisory authority, the Board did not possess significant authority. It can be argued that this situation had much in common with the fact that the various administrative committees that had been established as part of the post-war reform of the Government in Japan had subsequently either been abolished or turned into rubber-stamping organizations with no real power. In other words, with the principle of decentralization of authority failing to gain traction, systems like these did not take root.

So, the current Bank of Japan Policy Board system renews the mission of committee system. It fulfills the role of pooling the wisdom of the expert Board members concerning monetary-policy decisions. At the same time, it led the introduction of external members of Director in the board of private corporations in Japan. Under Heisei law, it is clearly stipulated that monetary-policy decisions by made by a majority vote at monetary policy meetings. Just as has always been the case at meetings of the Policy Board, government members are permitted to attend monetary policy meetings and state their opinions, yet the two government members no longer have voting rights. In addition, while the government members have the right to delay the adoption of a resolution until the next meeting, if exercised, this right is deemed to have been exercised by a Board member other than one of the government members.

The current Bank of Japan Law champions “open independence”. The Bank of Japan is subject to the Freedom of Information Act as a public body.¹⁸ Furthermore, actions such as semiannual reports to the Diet and the publication of meeting summaries and minutes are typical examples of accountability that provide evidence of policies that have actually been implemented. These sorts of accountability are the price the Bank of Japan has to pay for its independence in its policies and operations, and are particularly important as checks and balances for the Bank of Japan, over which supervision by the government and the Diet has been weakened.

On the other hand, the Bank of Japan has strengthened publicity. For example, with respect to the monetary policy, it has always published summaries and minutes of the Board meeting, and also given press conferences. The U.S. Federal Reserve also began holding press conferences in 2011 after meetings to determine policy (meetings of the Federal Open Market Committee (FOMC)), but the Bank of Japan has been doing so since Heisei law came into force. Regarding summaries, the Bank of Japan has speeded up publication of its financial and economic reviews, which express the Policy Board’s view of the economy, and since 2000 has published a report called the “Outlook for Economic Activity and Prices” (normally referred to as the “Outlook Report”), which gives the Policy Board’s outlook for the future of the economy. Later, it brought forward the timing of publication, and also extended the period covered by the outlook from the current fiscal year to the following fiscal year. This expansion in publicity partially fulfills accountability obligations as it allows policy decisions to be tracked. For example, as a means of integrating information provision with policy, an approach called “forward guidance” has been adopted for the purpose of disclosing future policy and influencing market expectations, and thereby, for example, controlling long-term interest rates.¹⁹

With regard to its budget, authorization from the Minister of Finance continued to be required, but the budget for monetary policy no longer needed to be approved. Also abolished was a provision that the government would cover the Bank of Japan’s losses if it ever ran short on capital. This set of measures served to prevent the government from ex-ante intervention in monetary policy, but they also mean that the Bank of Japan undertakes full responsibility for monetary policy.

2.2.5 Problems with the Current Bank of Japan Law

In the case of Japan, the period during which the amendment of the Bank of Japan Law occurred was, as described earlier, one in which the previous political system had reached a turning point marked by reforms. As for the economy, it was in an adjustment phase as the economy entered a low-growth era. In addition, liberalization of the financial system had been completed, so it was also a period of transition to new forms of financial sector. During this transition phase, the corporate sector went from being short of funds to having a surplus, which had a major impact on money flows by eradicating the excess demand for funds that had characterized the post-war financial system. At the same time, the accumulation of financial assets continued and assets began to play a greater role in the economy. Regarding the world economy, as the so-called globalization of finance progressed, a major change also occurred in the shape of the rise of the economies of neighboring Asian countries. The period of the amendment of the Bank of Japan Law was therefore a huge turning point in both politics and economics from both a domestic and international perspective.

During this period, Japan chose the large scale reform of the political and economic system. And in the area of the economy, the preceding trend was reflected in the promotion of a market economy in which government intervention and regulation was reduced and market mechanisms were respected. The principle behind major reforms such as deregulation, the decentralization of authority to regions, the demarcation of roles of the public sector and the private sector, and judicial reform was the promotion of decentralization and the strengthening of the independence of the Bank of Japan formed one part of that. The decentralization of authority is highly congruent with the promotion of market economy, in that individual entities are they themselves responsible for making decisions autonomously. It was hoped that this would open the door to new possibilities in the twenty-first century.

However, looking at what the subsequent reforms achieved, and at progress with regional decentralization of authority, various problems, including with judicial reform, have become apparent, and it cannot be said that adequate results have been made. These reforms have been “the reform of national governance system in Japan,’ which was accustomed to being ruled and tended to depend on the government,²⁰” yet politically, reforms such as local-government reform and judicial reform have only gone halfway, and in the area of economics and finance, a backdrop of prolonged economic stagnation and financial crises has actually led to the central government becoming more protective.

Fig. 2.1

Central Bank, Banking Sector, Economy

Looking back over the history of amendments to the Bank of Japan Law, considering that the amendments of the Bank of Japan Act of the Meiji period and the Bank of Japan Law of the wartime years during the Showa period contributed to the development of the economy during the Meiji period and the Second World War, even though there is room to discuss the soundness of their objectives, they represent a trend toward reforming systems to reflect major structural changes, and in that sense they can be said to have been successful. The current Law, on the other hand, was a response to new economic changes, success or failure in the future will depend on going back to the original principles with reform with those principles in mind. In that sense, the amendment of the new Bank of Japan Law are not yet finished.