The Making of Unconventional Monetary Policy and Business Models of Banks: Evidence from the Bank of Japan

Abstract

Which factors do central banks prioritize when making unconventional monetary policies (i.e., policy tools other than short-term interest rate manipulation)? While Japan was facing excessive yen appreciation and deflation starting in 2008, the Bank of Japan (BOJ) was reluctant to implement unconventional monetary policies despite strong criticism. This case can be considered as a deviant one in that it cannot be fully explained by extant theories. This study traces the process of the BOJ’s monetary policy making during 2008–2012 and hypothesizes that central banks prioritize the interests of their country’s dominant financial institutions when formulating policy. For instance, the BOJ emphasized lending by dominant financial institutions—banks—as a transmission mechanism to maximize monetary policy effectiveness. This was because Japanese banks had adopted a business model that was adversely affected by unconventional monetary policies. Therefore, the BOJ was reluctant to ease further due to concerns that excessively low interest rates would undermine the financial intermediary function.