Is the Bank of Japan a Closet Monetarist? Monetary Targeting in Japan, 1978-1988

Abstract

This paper investigates whether the Bank of Japan has practiced a monetarist rule since 1975. The Bank of Japan (BOJ) published a report in 1975, stating that it would pay close attention to money supply (M2), and in 1978 started announcing quarterly the "forecast" (targets) of monetary (M2) growth rate. Since 1975. the monetary growth rate has gradually declined, and inflation has subsided without causing a major fluctuation in output. This seems to be a successful case of the monetarist experiment. Has the EOJ practiced a monetarist rule, i.e., an announcement and maintenance of the K2 growth target? This paper reveals that it has not. The BOJ "forecasts" were quite accommodative in that an unexpected increase in actual money supply would make "forecasts" to allow a further increase in money supply. In other words, a "forecast" did not behave like a "target" under a strict monetarist rule. Testing a monetarist rule with "forecasts" is shown to be more powerful than testing with the actual process, under some weak assumptions. One of the necessary assumptions is that "forecasts" are rational expectations, and the rational expectations hypothesis is not rejected by the data. Thus, the conclusion of this paper is negative to a question posed by its title. Takatoshi