The Relationship Between Monetary Policy and Financial Stability of the Bank of Japan

Abstract

Since the late 1990s, the Bank of Japan, facing a zero lower bound on interest rates, as well as other major foreign central banks, have been dramatically tightening its monetary policy in response to inflation, which has depressed their profits and capital. Given that this approach to the monetary policy, accompanied by large-scale expansion of bank balance sheets, has the potential to have a large impact on central banks' finances in the event of monetary tightening, there is debate about the potential impact on central banks' ability to conduct monetary policy, and by extension, the confidence in their currencies.

Therefore, it is concluded that there is a relationship between central bank finances and the conduct of monetary policy. In a paper money system, confidence in the currency is not directly ensured by the assets owned by the central bank or its financial strength, but by the appropriate conduct of monetary policy to achieve the price stability. Based on this premise, central banks are usually organized in such a way that they make profits in the longer term. Therefore, even if a central bank temporarily incurs losses or has negative capital, this does not limit its ability to conduct monetary policy. However, this does not mean that a central bank can face unlimited losses and negative capital. If the financial risks of the central bank become the subject of excessive public scrutiny, there is a risk that trust in the regulator will diminish. Therefore, ensuring the financial soundness of the central bank is of great importance. It is concluded that the Bank of Japan will continue to pursue appropriate policies while paying attention to its financial soundness.