NRI Papers
No.94 September 1, 2005
  Direct Underwriting of Government Bonds by the Bank of Japan in the 1930s  
Toshiki TOMITA
      Since the late 1990s, a period which was plagued by a prolonged economic recession and continued concerns over deflation, a high level of interest has been shown in Japan's economic policy in the 1930s from the perspective that a remedy to get away from deflation might be found in the practices of Finance Minister Korekiyo Takahashi under which the Showa Depression was overcome. In this regard, by paying attention to the fact that Japanese government bonds were required for risk premiums in the international financial market from the end of the 1990s, this paper indicates that Japanese government bonds in the 1930s served as precedents for these bonds.
      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.
Contents
I Managed Currency System and Low Interest Rate Policy
  1 Lifting of the Gold Embargo and Overseas Securities Investment
  2 Re-embargo on the Export of Gold
  3 Details of Takahashi's Expansionary Finance
II Why Was Underwriting of Government Bonds by the Bank of Japan Implemented?
  1 Was an Option of Public Offering Available?
  2 Temporary Lending from the Bank of Japan Had Occurred in the Past
  3 Underwriting of Government Bonds on the Assumption of Open Market Selling Operation
  4 Impact of Open Market Operations in the United States and the United Kingdom
  5 Underwriting by the Bank of Japan, Rather than Buying Operation
III Changes in Selling Operations and Further Absorption of Government Bonds
  1 Occurrence of Changes in Selling Operations
  2 Further Absorption of Government Bonds at the Outbreak of the Sino-Japanese War
  3 Reduction of Interest Rates for Loans Using Government Bonds as Collateral
  4 Promoting the Sales of Government Bonds to Individuals
IV Warning from International Financial Market
  1 Did Fisher Effect Emerge?
  2 Financial Discipline Became Lax by Financial Isolation
  3 Disregarded Warnings from the International Financial Market

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