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Oil Crisis

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 and 3 special-purpose banks) Lack of government bond market

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Oil Crisis

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  1. Oil Crisis February 2003 Economics 272 Prof. Smitka

  2. 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 and 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

  3. Households Interbank Market Postal Savings Life Insurance Regional Banks City Banks Short-term FILP Long-term Corporations Infrastructure other Gov't Lending

  4. Financial institutions • City banks at core • typically net borrowers in the interbank market • 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

  5. Corporate Finances • Corporate finance was: • Own funds (retained earnings) • Bank borrowings • No bond market, little use of equities after 1963 • Personal savings was: • Banks (including postals savings) • Also life insurance (higher returns) • Real assets (real estate)

  6. 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

  7. 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 today 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

  8. 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]

  9. 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

  10. 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

  11. 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

  12. Implication • Japanese growth in the 1960s was not "Keynesian" • Cycles not driven by whims of investors and consequent swings of invesment and (through the multiplier) GDP • Instead, BOJ deliberately caused slowdowns • And, implicitly, allowed speedups • As per the following chart:

  13. 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

  14. No issue here!!

  15. 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

  16. 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 raise campaign funds for faction / political party • 1971 ¥/$ appreciation: end of “Bretton Woods” • huge inflow of dollars, bought to lessen forex shift but boosted money supply / lowered interest rates • Sum: stimulative MP, FP • Double-digit inflation by 1973

  17. 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

  18. Bank of Japan reactionsee also next charts on forex rate, discount rate and call rate

  19. Analytic issues • Time lags • Recognition • Implementation • Impact • Time consistency • Short-run versus long-run • Structural issues • Institutional change renders historical relationships (model parameters) misleading

  20. 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?

  21. 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

  22. 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

  23. 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

  24. Other aspects • FP side effects • Implications of lifetime consumption model • MP side effects • Do you really want low investment to persist? • Are big swings in forex rates desirable? • International side effects • How to respond to exogenous forex shifts?

  25. 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

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