On August 10 the Bank of Japan policy board announced that it was ending its zero interest rate policy, disregarding the advice of the government and numerous well-informed parties who had hoped to see the policy remain in place.

This was an extremely important decision when considering the future direction of the Japanese economy. Several problems were uncovered when we analyzed the decision-making process that went behind this policy change. The main problem was with the accountability of the Bank of Japan governor to clearly explain the rationale behind this decision to the Japanese people.

This is an essential element to maintaining the trust of the financial markets. If steps are not taken to remedy this problem, it may deal a serious blow to the Japanese economy some time in the future.

Before this policy decision was made, a debate, which captured the attention of the nation, was conducted within the Lower House Budget Committee. On August 2 and 3 Diet member Kozo Yamamoto raised many points in his questioning of Bank of Japan Governor Masaru Hayami at the Lower House Budget Committee Meeting. The following are excerpts from their exchange.

Yamamoto: There have been some signs that the economy is improving, but there are still concerns about employment and consumption. Exports have fallen off and we must contend with a strong yen. Lending by banks has decreased and there has been a curtailment in the amount of money. This being the case, why do you want to do away with the zero interest rate policy?

Hayami: I don't believe that a cancellation of the zero interest rate policy will necessarily lead to financial tightening. There has been much debate about how to continue a loose monetary policy . . . We have determined that conditions are such that we now have the prospect of eliminating deflationary fears. This has been one of our conditions for doing away with the zero interest rate policy.

Yamamoto: I wish you would explain the basis for your assumption that there will not be any financial tightening even if the zero interest rate policy is cancelled. And what do you mean when you say "we now have the prospect of eliminating deflationary fears"? I wish you would define this more clearly.

Hayami: It is not a matter of financial tightening. Interest rates are to be returned to their level before they were lowered to zero, while at the same time providing ample funds to the market. Deflationary fears refers to the downward pressures on prices that have resulted in a vicious cycle between the economy and prices . . . We have seen a considerable retreat from the latent downward price pressures brought about by weak demand.

Yamamoto: The Japanese economy is already in a deflationary state. There is a supply-demand gap. We are just now starting to see signs of a recovery. Should we now financially suppress this?

(Excerpts from the Lower House Budget Committee minutes, August 2)　　　

Such a debate was conducted, but Bank of Japan Governor Hayami's response was to avoid the debate. On August 9, Diet members Yamamoto and Yoshimi Watanabe and several well-informed people, notably Professor Mitsuhiro Fukao of Keio University, presented the emergency proposal entitled "The Bank of Japan Should not Rush To Eliminate Zero Interest Rates".

This sequence of events helped to reveal the decision-making process used by the bank of Japan regarding interest rate policy, and its responsibility for defining inflationary fears and its basis for this definition. Bank of Japan Governor Masaru Hayami may himself be unaware of the fact that the aggressive efforts needed to gain market confidence, in other words, the accountability to provide complete explanations, have not been carried out.

We feel that it is very unfortunate that the parties responsible for making such an important and definitive policy decision have failed to fully exercise their responsibilities and accountabilities. If the case is simply that Mr. Hayami is poor at providing explanations, then the policy group within the Bank of Japan will likely need to work on improving its public relations capabilities.