Reversal of Fortune: Macroeconomic Policy, International Finance, and Banking in Japan



Gary R. Saxonhouse and Robert M. Stern

market when the yen was appreciating, and leaning inthe market when the yen 201
was depreciating.                                                                    202

While agreeing with Ito that intervention was effective during the Sakakibara- 203
Kuroda period, Fatum and Hutchison find the massive interventions of 2003 in- 204
effective and the massive interventions of early 2004 actually pushing the yen in 205
the wrong direction. Fatum and Hutchison suggest that other studies of exchange 206
rate intervention by Japanese monetary authorities have found different results 207
possibly because they are contaminated by sample selection bias. Intervention 208
typically occurs during periods of abnormal exchange rate movements and not 209
when normal exchange rate market conditions prevail. To get around this problem 210
they match-up cases where economic circumstances were in every regard the same 211
except that in one case intervention occurred and in the other it did not. It is from an 212
analysis of these cases that Fatum and Hutchison draw their conclusions about the 213
effectiveness of intervention policy.                                                 214

Fatum and Hutchison also explore the hypothesis that the reduced effectiveness 215
of the intervention over the 2003-2004 period compared with the Sakakibara- 216
Kuroda period is related to the degree of sterilization. Did increased sterilization 217
mean a decline in the effectiveness of intervention? Interventions carried out by the 218
Bank of Japan on behalf of the Ministry of Finance are automatically sterilized 219
since the Ministry of Finance must first raise the necessary funds for foreign    220

exchange purchases by selling yen-denominated bills in the domestic market. The   221

real question is what action, if any, does the Bank of Japan take to unsterilize the 222
intervention? Fatum and Hutchison find that the Bank of Japan has not allowed   223

Ministry of Finance interventions to influence the day-to-day conduct of monetary   224

policy. In addition, they find no evidence that the Bank of Japan responded to 225
intervention action by the Ministry of Finance in 2003-2004 by increasing base 226
money at a rate faster than it might otherwise have done. Indeed, cumulative 227
foreign currency purchases by the Ministry of Finance were more than twice as 228
large as the increases in base money engineered by the Bank of Japan. The Bank of 229
Japan on its own was attempting to stimulate the economy in 2003-2004 through 230
rapid base-money growth, but this does not seem to have been influenced by the 231
exchange rate intervention policy of the Ministry of Finance. Much of this 232
intervention remained sterilized, in Fatums and Hutchinsons view, perhaps 233
accounting for its lack of effectiveness.                                              234

3.2 Exchange rate change and economic performance                            235

Unlike Ito, Ronald McKinnon rejects the use of exchange rate change as a tool for   236

economic adjustment. In Exchange Rate or Wage Changes in International   237

Adjustment? Japan and China versus the United States,he notes American-spon-    238

sored exchange rate adjustment has wreaked havoc with the Japanese economy in   239

the past, and will do so again in China and Japan today if they succumb today to US    240

pressure. McKinnon believes US government officials are mistaken if they believe   241

exchange rate adjustment will significantly alter international economic imbal-    242

ances. A yen or renminbi appreciation will raise the price of Japanese or Chinese   243

goods and services relative to foreign goods and services, discouraging their pur-    244

chases, but the appreciation also has a deflationary impact because of the loss in    245

value of the dollar assets each of these countries hold. As a result, the net impact of   246



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