The Bank of Japan (BOJ) has gone through a unique experience in the past few years. When I joined the Bank's newly formed policy board in April 1998, the overnight call market rate, the key policy instrument of the BOJ, was already below 0.5%. The economy was in the midst of the most serious recession in the postwar period, although it took us a little while to realise this. We guided the call rate down to virtually zero in the first quarter of 1999 and followed up by promising to keep it there until deflationary concerns had been dispelled. Finally, in August 2000, we brought the rate up to 25 basis points after having kept the zero rate for one and a half years.

In this short paper, I would like to discuss some of the key aspects of the evolution of our thinking on monetary policy over the period 1998–2000. In so doing, I would like to focus specifically on the characteristics of the 1997–98 Japanese recession, the transmission process of monetary policy in the neighbourhood of a zero rate and the background thinking behind the rate hike in August 2000.

The nature of the 1997–98 recession

It is appropriate to begin with a brief discussion of the nature of the recession that started in 1997(Q4), which is what the BOJ was trying to respond to in 1998–2000.