The MOF-BOJ Relationship
Understanding the distinct roles of the Ministry of Finance and Bank of Japan in JGB issuance, and clearing up common misconceptions
In [Section 2.1](/2.1/), we established the basic division: the MOF issues JGBs while the BOJ manages monetary policy. Since then, the BOJ has appeared throughout this chapter—holding half of outstanding JGBs, influencing yields, normalizing policy rates. But we've taken this institutional separation for granted. Why does Japan even have a separate central bank?
Why Does the Bank of Japan Even Exist?
The Bank of Japan (BOJ) was established in 1882 (Meiji 15) as Japan's central bank, modeled after European central banks—particularly the Banque de Belgique (Bank of Belgium). Its creation was part of Japan's broader modernization during the Meiji Restoration, when Japan was rapidly transforming from a feudal society into a modern industrial nation.
The Crisis That Forced Reform (1870s)
Before the BOJ's founding, Japan's monetary system was in chaos:
Pre-1882: The Currency Crisis
- Fragmented Currency System: Multiple currencies circulated—old Tokugawa-era coins, regional clan notes, new Meiji government notes. No unified national currency.
- Rampant Inflation: The Meiji government had financed the Boshin War (1868-69) and Satsuma Rebellion (1877) by printing inconvertible paper notes. By 1880, inflation exceeded 10% annually.
- Loss of Confidence: Paper notes traded at steep discounts to silver/gold coins. Foreign trade was hampered by currency instability.
- No Central Authority: No institution had monopoly power to issue currency or regulate the money supply.
Finance Minister Matsukata Masayoshi’s Reforms (1881-1885)
Finance Minister Matsukata Masayoshi (松方正義) studied European central banking and implemented radical reforms:
| Year | Reform | Impact |
|---|---|---|
| 1881 | Matsukata Deflation Policy Reduced government spending, withdrew inconvertible notes from circulation, committed to silver standard |
Painful short-term: GDP contracted, agricultural prices collapsed. But stabilized currency and prepared ground for central bank. |
| October 1882 | Bank of Japan Founded Established as Japan's sole note-issuing bank with ¥10 million capital (government provided ¥5 million) |
Created unified national currency. BOJ yen notes became only legal tender, replacing fragmented system. |
| 1885 | Silver Standard Adopted BOJ notes became convertible to silver at fixed rate |
Ended inflation crisis. Consumer prices stabilized. Foreign credibility restored. |
| 1897 | Gold Standard Adopted Convertibility shifted from silver to gold following Japan's victory in Sino-Japanese War (1894-95) and indemnity payment in gold |
Aligned Japan with major Western economies. Facilitated international trade and capital flows. |
BOJ’s Original Functions (1882-1942)
For its first 60 years, the BOJ operated as a relatively orthodox central bank:
- Monopoly Note Issue: Only institution authorized to print Japanese yen banknotes
- Bank for Banks: Provided lending facilities to commercial banks (lender of last resort)
- Government's Bank: Managed government deposits, conducted fiscal operations, but independently operated
- Discount Operations: Set discount rate to control credit conditions and maintain gold convertibility
- Currency Stabilization: Primary mandate was maintaining convertibility (first silver, then gold) and price stability
The Wartime Period and Loss of Independence (1942-1998)
World War II fundamentally altered the BOJ's role and independence:
The Dark Period: BOJ as Government Tool (1942-1945)
- 1942 Bank of Japan Act: Revised BOJ charter to make it explicitly subordinate to government. Governor required MOF approval for major decisions.
- War Financing: BOJ was forced to directly purchase government bonds to finance military expansion—exactly the practice Article 5 now prohibits.
- Hyperinflation Result: Money supply expanded 5x during 1937-1945. By 1945, inflation exceeded 500% annually. Post-war 1946-1949 inflation reached cumulative 5,500%.
- Lesson Learned: Central bank subservience to fiscal authority = loss of monetary discipline = economic disaster
Post-War Reconstruction (1945-1997)
After WWII, Japan rebuilt its institutions under U.S. occupation influence, but the BOJ remained only partially independent:
| Period | BOJ Status | Key Characteristics |
|---|---|---|
| 1945-1949 Occupation Era |
Under GHQ/SCAP control | Allied occupation forces (General MacArthur's SCAP) controlled monetary policy. Focus on stabilization and anti-inflation measures (Dodge Line 1949). |
| 1949-1970s High Growth Period |
Cooperative subordination to MOF | BOJ operated as "MOF's right hand" in implementing industrial policy. Low interest rates supported rapid economic growth (10% annual GDP growth 1950s-60s). Currency management focused on maintaining ¥360/USD fixed rate (Bretton Woods). |
| 1971-1985 Floating Rate Transition |
Increased autonomy on monetary policy, but MOF retained FX authority | 1971: Nixon Shock - U.S. abandoned gold standard, yen floated (¥360→¥308). 1973: Oil Shock - BOJ struggled to control inflation (23% peak). 1985: Plaza Accord - MOF led yen appreciation (¥240→¥120) to rebalance trade, BOJ implemented but didn't decide. |
| 1985-1997 Bubble and Crisis |
Growing tension between BOJ and MOF | 1985-1989: Asset bubble - BOJ kept rates too low too long, partly due to MOF pressure. 1989-1991: Bubble burst - BOJ raised rates but couldn't prevent crash. 1990s: Banking crisis - BOJ's lack of independence blamed for delayed response. |
The 1998 Reform: BOJ Independence at Last
The catastrophic 1990s banking crisis and "Lost Decade" made BOJ independence a political imperative:
The New Bank of Japan Act (1997, Effective April 1, 1998)
Why Reform Happened: The BOJ's inability to act decisively during the asset bubble (1985-89) and banking crisis (1990s) was attributed to MOF dominance. International pressure (IMF, OECD) and domestic political consensus demanded central bank independence as standard for developed economies.
Key Changes:
- Operational Independence: BOJ gained full authority to set monetary policy without MOF approval. Policy Board (9 members) makes decisions by majority vote.
- Clear Mandate: Primary objective is "price stability" (Article 2). BOJ defines this as 2% inflation target (adopted 2013).
- Governor Authority: BOJ Governor no longer requires MOF permission for policy decisions. 5-year term with limited removal conditions.
- Accountability: BOJ must explain policies to Diet (Parliament) but Diet cannot override monetary decisions.
- Separation of Functions: Monetary policy (BOJ) vs. Currency/FX policy (MOF) formally separated—this is the critical mandate split.
Modern Legal Framework:
The current Bank of Japan Act (revised 1997, effective 1998) grants the BOJ:
- Independence: Autonomy in setting monetary policy to achieve price stability (Article 2).
- Fiscal Agent Role: Legal obligation to handle the government's financial operations, including JGB auctions (Article 33).
- Prohibited Direct Financing: Article 5 of the Public Finance Act strictly prohibits the BOJ from directly purchasing JGBs at primary issuance (the "no monetization" rule).
The Critical Mandate Split: Why Currency Management Moved to MOF
The 1998 reform clarified a crucial division of responsibilities that often confuses observers:
BOJ vs MOF: The Modern Division of Labor
| Responsibility | BOJ (Bank of Japan) | MOF (Ministry of Finance) |
|---|---|---|
| Monetary Policy | ✓ Full authority (interest rates, QE, YCC) |
✗ No authority (can "request" but not order) |
| Price Stability / Inflation Target | ✓ Sole responsibility (2% target) |
✗ No direct role |
| Currency Value / Exchange Rate | ✗ No authority (BOJ can only implement MOF's decisions) |
✓ Full authority (decides when/how to intervene) |
| FX Intervention Operations | ✓ Execution only (MOF orders, BOJ executes) |
✓ Decision authority (Minister of Finance approves) |
| Foreign Exchange Reserves | ✗ No ownership | ✓ Owns and manages (¥1.3 trillion USD reserves) |
Why This Split Exists: Historical and Legal Reasons
The separation of currency management from monetary policy reflects lessons learned from Japan's post-WWII history:
- Bretton Woods Legacy (1949-1971): During the fixed exchange rate era, MOF managed the ¥360/USD peg as part of fiscal/trade policy. When rates floated after 1971, this authority remained with MOF rather than transferring to BOJ.
- Fiscal Policy Link: Exchange rate affects trade balance, government revenue, and debt sustainability. MOF as fiscal authority needs control over FX policy to coordinate with broader economic strategy.
- International Coordination: G7/G20 currency agreements (like Plaza Accord 1985) are negotiated at ministerial level. MOF represents Japan in these forums, not BOJ.
- 1998 Reform Philosophy: Gave BOJ narrow, clear mandate (price stability) to maximize credibility. Currency management involves political trade-offs (exporters vs importers) unsuitable for independent central bank.
FX Intervention: A Brief Example of Institutional Cooperation
Foreign exchange intervention illustrates the MOF-BOJ division of responsibilities. When MOF decides intervention is needed to address excessive yen volatility, BOJ executes the trades as MOF's agent using the Foreign Exchange Fund Special Account. MOF owns Japan's $1.3 trillion in foreign reserves and makes policy decisions; BOJ provides technical execution through its Financial Markets Department.
Recent examples include September-October 2022 (¥8.3 trillion spent as USDJPY hit ¥151) and April-July 2024 (¥15.3 trillion as USDJPY reached ¥161). These interventions showed that MOF can smooth volatility but faces limits when fighting large interest rate differentials—the July 2024 intervention succeeded partly because BOJ simultaneously hiked rates to 0.25%, aligning policy with intervention goals.
Clarifying the Common Misconception
This is one of the most commonly misunderstood aspects of JGB issuance, and it is critical to get right.
Common Misconception: The BOJ "prints money" for the MOF, or that the BOJ "buys the government's debt" at the auction to fund the deficit.
This is incorrect and legally prohibited.
The Correct Framework (The "Two Markets"):
Think of the process in two distinct, separate stages:
1. The Primary Market (The Auction):
- Who: MOF (Seller) → Private Banks (Buyers, e.g., Primary Dealers).
- BOJ's Role: The BOJ is just the "auctioneer" and "cashier." It runs the sale but does not participate as a buyer. Its job is to manage the auction and settle the trades, taking cash from the private banks and giving it to the MOF.
- The Law: This separation is mandated by Article 5 of the Public Finance Act, which explicitly forbids the BOJ from "underwriting" (buying at auction) government debt. This is to maintain monetary discipline and prevent the government from forcing the central bank to finance its spending (which leads to hyperinflation).
2. The Secondary Market (Everyday Trading):
- Who: Private Bank A (Seller) → Private Bank B, a pension fund, or... the BOJ (Buyers).
- BOJ's Role: *Here* is where the BOJ buys JGBs. As part of its monetary policy (like Quantitative Easing), the BOJ goes into the open market and buys existing JGBs from the private banks that bought them at auction.
- The Purpose: The BOJ does this not to fund the government, but to to influence interest rates (e.g., push the 10-year yield down) and inject liquidity into the banking system to achieve its inflation target.
In Summary: The MOF sells bonds to private banks. The BOJ then buys those bonds *from* the private banks. This legal and operational separation, however thin it may seem in practice, is fundamental to the structure of Japan's financial system.[^1][^2]