Modern Monetary Policy in Theory and Practice

Central Banking and Financial Markets

Markus Heckel, University of Duisburg-Essen [About | Email]

Volume 11, Issue 2 (Book review 3 in 2011). First published in ejcjs on 31 May 2011.

Shirakawa Masaaki (2008) Gendai no Kin'yū Seisaku: Riron to Jissai [Modern Monetary Policy in Theory and Practice: Central Banking and Financial Markets], (in Japanese), Tokyo: Nihon Keizai Shinbun Shuppan Sha, ISBN: 978-4-532-13344-3, 445 pages.


Shirakawa Masaaki is a graduate in economics of the University of Tokyo and University of Chicago. He joined the Bank of Japan (BOJ) in 1972, leaving in 2006 to take up a professorship at Kyoto University. In April 2008 he returned to the BOJ to become the bank's 30th governor.

Gendai no Kin'yū Seisaku (Modern Monetary Policy) was published approximately one month before Shirakawa took up the helm of the BOJ, thus providing readers with an extraordinary opportunity for a detailed insight into the mind of a central bank governor. Indeed, the book represents the first time that a BOJ governor has written an in-depth textbook on monetary policy so close to actually taking up one of Japan's key financial appointments. An obvious explanation for this incredible occurrence would be that Shirakawa did not expect the appointment, a situation which holds out the promise that within its pages the book will provide a rare opportunity to listen to the governor's 'original voice' both on his theoretical views regarding central banking (parts 1–5) and on his view of practical monetary policy decisions (part 6).

Inevitably, given this extraordinary set of circumstances, Gendai no Kin'yū Seisaku received considerable attention in the Japanese media when it was published. Shirakawa himself was astonished by the book's sales success and stated before the parliamentary fiscal and finance committee that the book had 'sold more than I thought'. Some of the publicly-known readers of the book—for instance, Daimon Mikishi, policymaker from the Communist Party, the only party which opposed Shirakawa's appointment—were also complimentary in their reviews. Daimon (2008) observed that 'six thousand yen is slightly expensive, but the book is worth it'. The book's list of acknowledgements also contains some prominent figures, many of whom have BOJ backgrounds. These include Deputy Governor Yamaguchi Hirohide, Yamaguchi Yutaka, deputy governor from 1998 to 2003, Ueda Kazuo, Policy Board member from 1998 to 2005 and Ōkina Kunio, former director of the Institute for Monetary and Economic Studies (IMES), the BOJ's research institute (page v).


The book is not an autobiography filled with anecdotes, as was the case with former Chairman of the US Federal Reserve Alan Greenspan's 2007 memoir, The Age of Turbulence. Instead, it is a textbook of monetary policy or, to be precise, of central banking. Nonetheless, it is by some measure different to conventional textbooks (e.g. Walsh 2010). Instead of presenting abstract theoretical models of monetary theory and policy with analyses of real and nominal economic variables, Shirakawa relies on his 'own experience' as a career central banker (page ii). In general, the book avoids complicated mathematical formulas, thereby making it accessible to a wider range of readers, although those with no background in economics and central banking will still find the text to be challenging. Moreover, there is an immense number of quotes in the text, many in English, and so unsurprisingly English-language references exceed Japanese sources.

The book is divided into six main parts and twenty chapters. The first part explains the goals of monetary policy, concentrating on price stability. The second explains the workings of decision-making in monetary policy, including an analysis of the governing bodies of prominent central banks. The third and fourth parts focus on how central banks conduct monetary policy (e.g. how they control interest rates). The fifth part deals, amongst other things, with foreign exchange interventions (chapter 14), financial markets and systems (chapter 15) and the relationship between monetary and fiscal policy (chapter 16). In general, these five parts describe the view of orthodox textbooks on monetary economics and monetary policy. However, compared to most other textbooks (see above), they examine the functions and operations of central banks in more detail; for instance, the book includes many examples and comparisons with the world's main central banks, such as the BOJ, US Federal Reserve, European Central Bank and Bank of England.

One minor criticism concerns the citation of the political autonomy index by Arnone, et al. (page 99). Shirakawa assesses the term of Federal Reserve's FOMC members under five years (i.e. the Fed scores in this book only four instead of the correct five points). Yet, this in fact contradicts the data presented by Arnone, et al. (2006) and Grilli, et al. (1991).

Quantitative Easing Policy

The book's most refreshing analysis is contained in the sixth part, which looks at works on recent economic developments and monetary policy experiences of the BOJ. In comparison to the previous parts, Shirakawa offers here his own views on some of the contentious issues in monetary policy-making (page 344). Of particular note are the quantitative easing policy (QEP) implemented between 2001 and 2006 (chapter 18, pages 344–70), deflation and the zero interest rate bound (chapter 19, pages 371–92), and monetary policy during the asset price bubble (chapter 20, pages 393–417). The sixth part also deserves special attention, because it is relevant not only for the BOJ but also for other central banks as low interest rates and QEP have become a common policy framework in many developed countries.

Recent severe economic conditions have provided a challenging environment for Japan, and the BOJ has struggled to achieve its main policy goal of price stability. In March 2001 it implemented the unprecedented QEP framework in which the main operating target of monetary policy was changed from the overnight call rate to the outstanding balance of the current accounts held by financial institutions at the BOJ. From 2001 to 2006, current accounts were gradually raised from 5 trillion yen (March 2001) to 30 to 35 trillion yen (January 2004 to March 2006) (pages 347–48). Another important pillar characterising QEP has been the commitment to maintain QE until the core consumer price index rises to a stable zero percent or above (pages 345–49).

During the QEP period Shirakawa acted as head of the Policy Planning Office (2000 to 2002) and as executive director in charge of monetary policy and financial markets (2002 to 2006). He was not convinced of the effectiveness of QEP, believing that 'zero rates were creating bias, or distortions, in the market', thereby increasing the risk of moral hazard (Clenfield 2008). In Gendai no Kin'yū Seisaku, he concludes that the increase of the quantity of money during QEP had little impact on the economy or the behaviour of market participants and, as a consequence,failed to bring about economic recovery. Nonetheless, the commitment effect did help to stabilise the financial system by providing ample liquidity to the markets (pages 365–66). In addition, Shirakawa is somewhat critical of the government for maintaining a tight fiscal policy during the QEP period due to the problem of growing debts (page 360). It is possible to ask, however, whether QEP might have produced different results if the government had supported the BOJ's efforts by increasing government spending.

Accountability and Transparency

Based on Article 3(2) of the Bank of Japan Law, Shirakawa stresses the importance of accountability and transparency of independent central banks in a democratic society (pages 108–10; chapter 12). In addition, the issue of macroeconomic forecasts receives a whole chapter (chapter 10). Ahearne, et al. (2002) find that forecasts of the Japanese economy have been in general quite optimistic regardless of whether they were made by a central bank, private economists or international organizations (e.g. the International Monetary Fund). For instance, most economists failed to foresee the rise of deflationary tendencies in the Japanese economy in 1995 (pages 199–201). In other words, forecasts are characterized by an optimism bias (Belke and Polleit 2009: 709) which suggests that improvements are needed in this field. Since Shirakawa took charge, the BOJ has improved its transparency and now explains policy decisions in more detail. Most importantly, the Policy Board provides explanations even in cases where there has been no change in monetary policy. In addition, the BOJ has increased the number and the time-horizon of its forecasts concerning both the growth rate and the inflation rate (Shirakawa 2008). These improvements in communication strategy support the central banks credibility and improve the efficiency of monetary policy (page 110). Enhanced transparency has another positive effect: it strengthens the central banks independence, because politicians find it more difficult to interfere in monetary policy.

Recent developments: Interest rates and foreign exchange rate interventions

The book's alternative English title is Modern Monetary Policy in Theory and Practice and Shirakawa makes a welcome contribution to the literature of theoretical issues in central banking and practical decisions in monetary policy. However, two striking examples demonstrate that the long-standing debate between theory and practice in monetary policy is fraught with many problems. First, based on an analysis of QEP, Shirakawa states that the BOJ 'should have committed to a low but positive interest rate rather than zero' (page 367), indicating that he is rather sceptical about zero rates. Indeed, after the Lehman Brothers shock in September 2008, the Shirakawa-led BOJ was reluctant to cut rates. The Policy Board avoided aggressive cuts and preferred instead to reduce rates gradually. In October 2008, the BOJ cut the rate to 0.3 percent, only to reduce it further less than two months later, this time to 0.1 percent. Finally, in October 2010, in an unexpected move, the rate was cut to virtually zero, at a range of around 0.0 and 0.1 percent, arguably because of political pressure from the government and opposition parties. This demonstrates that Shirakawa was unwilling to go back to zero interest rates, 'as this would weaken market functioning and distort the allocation of resources because of the contraction of the interbank market and an intensified moral hazard for banks' (Kanno 2009, 13). In this context, it is interesting to note that,at his first press conference after becoming governor, Shirakawa stated that his monetary policy stance could not simply be characterised as dovish or hawkish (Bank of Japan 2008).

The second example concerns exchange rate interventions (chapter 14). Shirakawa remarks that most industrialised countries do not intervene in the foreign exchange market (page 296) and he seems to doubt the efficiency of interventions, which can only be successful if they are bound with necessary conditions (e.g. they must be coordinated with other countries). Shirakawa argues that unilateral currency interventions hardly ever have positive outcomes, noting that 'it is hard to expect that exchange market interventions without coordination are effective' (page 291).

In practice, however, as BOJ governor, Shirakawa has taken a different position to that offered in Gendai no Kin'yū Seisaku (page 291). After the yen surged to a 15-year high against the US dollar in September 2010, threatening the recovery of the Japanese economy, the government started to conduct yen interventions for the first time since 2004. In a statement on 15 September, Shirakawa declared that the 'Bank of Japan strongly expects that the action taken by the Ministry of Finance in the foreign exchange market will contribute to a stable foreign exchange rate formation' (Bank of Japan 2010). This was repeated in 2011. Driven by speculation the yen climbed to an all-time high of around 77 yen to the US dollar in March. In response, the Japanese government started yen interventions and the currency weakened to a level of around 81 to 83 yen to the US dollar.

What was different this time? The interventions were now being carried out in cooperation with the G7 nations, thereby increasing the chance of success, as Shirakawa argues in this book. Such cases nonetheless demonstrate that it is easier to write a (theoretical) book than take on a public position dealing with practical problems. As BOJ governor, Shirakawa is a potential target for political pressure and might be obliged to support or implement policies in which he does not always believe. Overall, however, Gendai no Kin'yū Seisaku is an excellent book, and by providing such a unique insight into what a public official might 'really think', it should appeal to all those interested in central banking and monetary policy.


Ahearne, Alan, Gagnon Joseph., Haltmaier, Jane, and Steve Kamin (2002) 'Preventing Deflation: Lessons from Japan's Experience in the 1990s', International Finance Discussion Papers 2002-729, Board of Governors of the Federal Reserve System.

Arnone, Marco, Bernhard J. Laurens and Jean-Francois Segalotto (2006) 'Measures of Central Bank Autonomy: Empirical Evidence for OECD, Developing, and Emerging Market Economies', IMF Working Paper, 06/228.

Bank of Japan (2008) 'Summary of the Press Conference 9 April 2008', 10 April.

——— (2010) 'Statement by the Governor', 15 September.

Belke, Ansgar and Thorsten Polleit (2009) Monetary Economics in Globalised Financial Markets, Berlin, Heidelberg: Springer Verlag.

Clenfield, Jason (2008) 'Masaaki Shirakawa Brings Chicago-School View to BOJ', Bloomberg, 10 April.

Daimon, Mikishi (2008) 'Zaisei Kin'yū Iinkai (Nichigin Hōkoku ni taisuru Shitsugi): "Ryōteki Kanwa Saku wa Ijō", Nichigin Sōsai ni Tadasu', 27 May.

Greenspan, Alan (2007) The Age of Turbulence: Adventures in a New World, New York: Penguin Books.

Grilli, Vittorio, Masciandaro, Donato and Guido Tabellini (1991) 'Political and Monetary Institutions and Public Financial Policies in the Industrial Countries', Economic Policy, 6(13): 342–392.

Kanno, Masaaki (2009) 'How the BOJ's Quantitative Easing did and will Work', J. P. Morgan, Economic Research, Global Data Watch, January 2, 9–14.

Shirakawa, Masaaki (2008) 'The Recent Economic and Financial Developments and Their Outlook, and the Conduct of Monetary Policy in Japan', BIS Review, 95/2008, 1–8.

Walsh, Carl E. (2010) Monetary Theory and Policy, third edition, Cambridge: The MIT Press.

About the Author

Markus Heckel is a PhD candidate at the University of Duisburg-Essen, Germany. He graduated in Japanese studies with a minor in economics from the University of Bonn in 2006. In 2008, as a visiting research fellow at the Institute for International Monetary Affairs (IIMA) in Tokyo, he conducted research on the Bank of Japan. The working title of his PhD thesis is Central Bank Reform and Independence – A Case Study of the Bank of Japan.

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