Japanese Monetary Policy
The Bank of Japan left its operating target, the uncollateralized overnight call rate, unchanged at 0.25 percent in January. Observers expect that the bank’s next move will be upward. The timing of any move remains uncertain and depends on the outlook for economic activity and prices.
The Japanese economy, which grew at a modest pace over the last couple of years, slowed in 2007:IIIQ as consumer spending dropped precipitously. Most economists expect its growth to continue at approximately 2 percent this year. That rate seems slightly faster than Japan’s potential for economic growth, implying persistent, yet very moderate, upward price pressure. The inflation rate probably will not exceed 0.5 percent on a year-over-year basis in 2007. The Bank of Japan maintains an informal inflation target of 0 percent to 2 percent for core inflation. An inflation rate of 0.5 percent, however, would leave the real overnight call rate negative.
On March 9, 2006, the Bank of Japan announced an end to its quantitative easing policy. Under that operating procedure, the Bank of Japan set a target for current account balances—essentially, non-interest-bearing reserve deposits that financial institutions maintain at the Bank of Japan. Between 2004 and 2006, the procedure left substantial amounts of excess reserves in the Japanese financial system. These reserves have since dissipated, allowing Japanese short rates room to rise somewhat.