|No.94 September 1, 2005|
|Direct Underwriting of Government Bonds by the Bank of Japan in the 1930s|
Prior to the implementation of the underwriting of government bonds by the Bank of Japan, measures were adopted to increase the liquidity of government bonds owned by financial institutions to reduce and eliminate interest risks. Specific measures include loans at the official discount rate by using government bonds as collateral, a change from market value to book value (issue price) in evaluating government bonds owned, the enforcement of the Capital Flight Prevention Law and control of overseas investment by the Foreign Exchange Control Law.
The underwriting of government bonds by the Bank of Japan started in November 1932. While the selling of government bonds on the market by the Bank of Japan was smoothly implemented at first, changes started to occur in the latter half of 1935. Although a policy to reduce the amount of government bonds issued was announced, this policy that could lead to the reduction of military expenditures invoked a backlash among the military. Immediately after the coup in 1936 known as the February 26 Incident, the official discount rate was lowered, and 3.5-percent interest-bearing government bonds again started to be smoothly absorbed by financial institutions.
With the outbreak of the Sino-Japanese War in July 1937, Japan shifted from its quasi-wartime structure to a wartime structure. Measures to absorb government bonds were strengthened, and the amount of government bonds exceeding the nation's economic scale was "smoothly" absorbed. This means that government bonds were jammed into a Japanese economy that was isolated by controls imposed on the transfer of funds.
Under the controlled domestic government bond market, the interest rate remained stable at a low level until the end of the war, and a huge amount of government bonds was absorbed. However, the interest rate of pound-denominated Japanese government bonds on the London market had already started to increase substantially at the time of the Manchurian Incident after September 1931. This reaction was as if the London market had anticipated Japan's defeat and subsequent inflation.