Free The Alchemists: Three Central Bankers and a World on Fire by Neil Irwin

Ichimada, first appointed with the approval of U.S. occupiers in 1946, was so powerful that, a colleague once explained, “ He was called Pope , because under him the central bank’s power was stronger than that of the government.” When Kawasaki asked for permission to build a steel plant, Ichimada answered, “ Japan does not need any more steel ,” adding that “I can show you how to grow [the wild herb] shepherd’s purse there.”
    In the years that followed, the BOJ became a more conventional central bank. In the late 1980s, as the speculative bubble was inflating, all that money the banks were pumping out was going to bid up the prices of assets like office buildings and shares of stock—not driving up the prices of rice or gasoline. With inflation well under control, the BOJ saw no need to tighten the money supply, and the boom continued unabated. By 1989, when things were getting truly out of control, the bank finally hiked interest rates, trying to prick the bubble. In hindsight, the action succeeded all too well.
    The end of the Japanese bubble wasn’t so much a pop as a fizzle. Soon, the very cycle that had led to ever-rising asset prices and bank lending was working in reverse: Prices for real estate and other assets fell, banks faced losses so they cut back on new lending, and economic growth ground to a halt. In the early 1990s, the Bank of Japan did what a central bank is supposed to do when the economy weakens: It cut interest rates, giving businesses more incentive to invest for the future and consumers more incentive to spend their money instead of save it. But it did so slowly, failing to understand the degree to which the national economy was in peril. It lowered its rate from 6 percent in 1991 to 0.5 percent in 1995. The Japanese economy seemed to improve a bit in 1996 before resuming its fall in 1997.
    In a milder version of the deflation that paralyzed the world economy in the early 1930s, prices were stagnant to falling. That made the overhang of debt incurred in the boom years even more onerous, as the yen being used to repay loans were more valuable than those that had been originally lent out. Steady deflation even made the BOJ’s low-interest-rate policies less effective at boosting growth, because it meant that “real,” or inflation-adjusted, interest rates were higher than they would have been during a time of inflation.
    On March 20, 1998, Masaru Hayami, a longtime corporate executive who had worked at the BOJ many years earlier, became the central bank’s twenty-eighth governor. It was four days before his seventy-third birthday. He inherited a once booming economy that was mired in nearly a decade of economic stagnation and falling prices. The usual tool a central bank uses to guide the economy was already proving ineffective. What could Hayami-san do to try to fix the Japanese economy? And, more importantly, what
would
he do?
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    E conomists call it ZIRP: zero-interest-rate policy. The challenge that Hayami inherited—and which seemed at the time to be a uniquely Japanese phenomenon—was that the Bank of Japan had already cut rates to zero and the economy was still lousy. Cutting interest rates further isn’t very plausible. A negative rate would mean, in effect, charging bank customers to keep their money in savings accounts, and would lead to people taking their money out of banks to avoid that charge.
    As Japan started grappling with this problem in the late 1990s, some of the biggest minds in academic economics, both Eastern and Western, started coming up with possible solutions, arguing that the BOJ still had plenty of ability to boost economic activity—if it was courageous enough to act. They pointed out that because the institution had the unique and unlimited ability to create Japanese currency, there was no reason it had to allow the yen to become too dear. The BOJ, for example, could pledge to keep its low interest rates in place for many years