11 - Monetary policy and political economy: the Federal Reserve and the Bank of Japan

Summary

The monetary experience of Japan over the past decade provides an example of a nation that has effectively stabilized its domestic inflation rate in the face of major internal and external shocks, while simultaneously avoiding recession. Japan did experience a short period of double-digit inflation around the time of the 1973 oil price shock that was higher and initially more disruptive than in the United States. However, Japan's response to that experience was the introduction in 1973 and 1974 of an explicit price stabilization strategy that quickly reduced the nation's “core inflation” to the lowest among the major industrial countries.

Four important aspects of the relative performances of the U.S. and Japanese economies since 1975 are shown in Figure 11.1. The panels on the left show that monetary growth and inflation in Japan have been more stable than in the United States. The panels on the right show that Japan has experienced a smaller degree of disruption in the real and financial sectors, as reflected by the unemployment rate and the gap between unregulated and regulated interest rates.

This chapter focuses on the differing monetary policy experiences of the United States and Japan as an explanation for the differences between the two nations' macroeconomic performances. We attempt to isolate reasons for the differences in monetary policy experiences. In particular, we argue that the differences cannot be found in the technical characteristics by which the Federal Reserve (FR) and the Bank of Japan (BOJ) formulate and execute monetary policy; rather, the differences are more fundamentally rooted in the institutional and political environments in which the two central banks operate.