The initial primary role of central banks was to act as the government banking system; however, over the years, the responsibilities have evolved to the extent that they mainly focus on formulation and regulation of monetary policies to enhance sustainable economic growth. Therefore, Central banks act as the state's monetary authority, and they contribute significantly to the achievement of a country's macro-economic goals. Although most countries apply a similar central bank governance structure, the system shows some distinctions based on the monetary policy tools and procedure. Consequently, some countries have a superior central banking system due to different states' distinct economic policies and processes. Exploring the United States central bank- Federal Reserve and the Bank of Japan (BOJ) structure and operation will outline the differences and similarities, subsequently illustrating which bank is superior to the other.
An Introduction Overview of Federal Reserve and Bank of Japan
Japan is located on the East coast of Asia. The country has experienced tremendous economic growth over a few decades; however, it has failed to explore its maximum potential. Some of the factors limiting Japan to explore its full potential in economic growth include lack of proper monetary policies to increase the Global Domestic Product (GDP). These factors reflect the inefficiency of Japan's central banking system through the BOJ. Japan's economic freedom score is currently recorded at 73.3 %; thus, it is in position thirty worldwide (Chaudhuri, 2018). Indeed, Japan appears to have a remarkable economic performance but can achieve more with slightly improved central banking system policies. Japan uses the Bank of Japan as the central bank established in 1882 under the bank of Japan act ( Chaudhuri, 2018 ). After the Japanese held numerous discussions to decide whether to apply the European or the American banking system, most agreed on the American system banking system. As a result, national banks and the central bank were established.
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Both the Federal Reserve and the Bank of Japan generate their finance from the national banks' reserve amount and other interests. Additionally, the two institutions receive financial support from the government; however, the Federal Reserve bank requests a smaller government deposit than the BOJ. Bank of Japan's total capital is about a hundred million yen, and the government generates fifty-five percent (Chaudguri, 2018). However, although the two entities receive monetary aid from the government, they operate independently and autonomously. The government officials do not intervene in the decision-making process.
The two banks play important financial roles in their respective states. One of the most significant roles includes participating in the financial intermediation process, borrowing, and lending money. Commercial banks help in connecting borrowers and lenders. In the financial intermediation process, people with surplus money transfer to those who need to use those funds. In most times, financial institutions like commercial banks act as the intermediary channel. Most countries' central banks participate in the financial intermediation process. For instance, the Federal Reserve of the United States regulates the entire process and enhances a conducive environment for excellent bank mediation.
Furthermore, the Federal Reserve has formulated policies that reduce borrowing costs to increase borrowers' fund accessibility. Similarly, Japan's bank also plays a critical role in the financial intermediation process by acting as the last resort lender. However, because it cannot give private firms and individuals money, it issues the money to commercial banks that lend to borrowers. The firms that desire to lend their money deposits their money in commercial banks where borrowers request loans. The central banks act as the overseer and regulator of the entire process.
Comparison of Federal Reserve and BOJ Based on Macroeconomic Conditions
Macroeconomic Conditions Observed by Federal Reserve
The Federal Reserve aims at promoting the USA economy by improving specific macroeconomic factors. Some of these factors include reducing unemployment, managing inflation, and increasing its Gross Domestic Product (GDP). American congress has granted the Federal reserve mandate to formulate and regulate monetary policies to improve its economy. The central bank of America uses several tools to achieve economic goals. One of the primary tools used to control inflation and unemployment is the federal funds rate, which is an interest rate paid by national banks for overnight borrowing in the federal fund markets (Komlos, 2021). The federal fund rates affect commercial banks' interest rates, thus influencing households' and firms' borrowing rates. For instance, when banks provide loans at low-interest rates, consumers and businesses may be willing to purchase more because of increased funds.
Consequently, an increase in demand requires companies to supply more products, forcing them to employ more staff. As a result, the employment rate increases. However, increased money supply in the market may lead to inflation, and for the Federal Reserve to reverse this condition, it increases the federal funds' rates.
The average unemployment rate in the United States from 1994 -2019 was 10.5%, but the percentage has been reduced to 6.3% (Komlos, 2021). Indeed, the Federal Reserve has done a recommendable job in regulating the level of unemployment to the extent of reducing it below the market expectation. The USA central bank achieved this by reducing the federal market funds and the treasury mortgage, thus increasing the money supply. Additionally, the federal reserve might have expanded the fiscal policy by allowing the government to spend more on projects that can create jobs and also increases cashflow in the market. Furthermore, money increase in the market leads to positive GDP. Growth in GDP is a reflection of a thriving and robust economy and vice-versa. The USA has managed to maintain a steady annual rise in GDP. In the 2020 annual figures, the GDP had increased by 33.4% (Cavallo, 2020). Such progress is a clear indication that the USA economy is stable.
Additionally, the United States inflation rate has been decreasing steadily since 2017. The current inflation rate in the USA is around 0.9% (Cavallo, 2020). Considering that the whole world economy was affected immensely by the covid19 pandemic, it is justifiable to applaud the USA for maintaining a 0.9% inflation rate through the coronavirus crises. Due to the Federal Reserve's efforts to maintain a low inflation rate, the USA economy is ranked among the stable worldwide economies. Furthermore, the USA dollar is considered one of the most potent currencies in the world. The federal reserve conducts regular inflation measures using a price index; thus, regulating the inflation rate.
Overview of Japan's Macro-economic Factors
Japan's economy illustrates tremendous growth, which some of the macroeconomic factors can prove. Based on Japan's current reports, the unemployment rate is at 2.34% (Chaudhuri, 2018). The decreased unemployment rate is one of the factors that signifies a stable economy. However, Japan's inflation rate, which is -0.98%, currently may indicate a threat to economic growth (Chaudhuri, 2018). A moderate inflation rate is beneficial to a country's economy because it enhances growth. Japan's inflation statistics indicate that it may encounter economic stagnation due to decreased money and credit supply in the market. Lastly, Japan's GDP is around 4.9 trillion dollars (Chaudhuri, 2018). From 2010 to the current year, Japan has indicated unstable GDP statistics. The GDP has been increasing and decreasing slightly throughout the years. However, even when Japan's GDP falls, it is usually higher than in most countries. As a result, the economy is not affected adversely, but unstable GDP still indicates economic uncertainty.
Economic Performance of Japan and USA
Based on the two countries' macroeconomic condition findings, one can make inferences on the best performing states. Based on the unemployment rate, Japan appears to be performing better than the USA, with an average difference of 3.96%. A country with a low unemployment rate signifies a stable economy with decreased cases of poverty. Additionally, Japan's inflation rate is relatively low in comparison to the USA. Over the years, Japan has managed to maintain an inflation rate below 2%. USA inflation rate is also low based on the Federal reserve ideal percentage; however, it is higher than Japan's. A country with a low inflation rate can survive an economic recession than one with higher inflation. However, a very low inflation percentage can signify potential threats to economic growth. Lastly, United States GDP is higher in comparison to Japan's. Based on all the differences noted in the macroeconomic factors between Japan and the USA, it is clear that both states have an excellent economy. However, the USA's economy appears to be more robust compared to Japan's.
Bank of Japan and Federal Reserve Monetary Policy
Monetary Policy Tools
Both BOJ and Federal Reserve formulates and implements policies that influence the macroeconomic conditions to achieve the countries' economic goals. The entire process requires a strategic implementation plan to ensure that the central bank achieves its goals. Monetary authority institutions use several tools to conduct monetary policy processes. Countries may use similar or different mechanisms. As a result, some states might achieve their economic goals. Some may not. The BOJ and federal reserve apply an almost identical framework of monetary policy of controlling the money supply. However, at some points, they use different operation practices to implement the framework.
The Bank of Japan's primary tools and the federal reserve include open market operations, reserve requirements, and discount rates (Cargill, 2017). The free markets operations are performed by the central bank of either selling or buying securities to or from national banks. When there is a limited money supply in the market, the BOJ and Federal Reserve purchase securities from the commercial banks. As a result, the two central banks grant commercial banks money to lend to private firms and individuals. Consequently, increasing money supply. On the other hand, when there is a surplus, BOJ and Federal Reserve sell securities to national banks, reducing the amount of money available for lending.
The reserve requirement is a percentage of money that BOJ and federal reserves demand the commercial banks to deposit. This amount is determined by the amount of money deposited by savers in commercial banks. The central banks require a certain percentage of the total deposit. As a result, it regulates the amount of money that is supplied. When there is a deficit of money in the market, the central banks, including BOJ and Federal Reserve, reduce the reserve requirement amount to increase circulation funds and vice versa. Lastly, the discount rate is the amount of money that Central banks charge commercial banks for borrowing money from them. National banks borrow from the central banks if they cannot get funds from their counterparts, financial institutions.
BOJ and Federal Reserve Application of Monetary Tools
Open Market operations
The Bank of Japan applies two primary strategies to achieve open market operations- fund providing and fund absorption activities ( Chaudhuri, 2018 ). BOJ conducts several funds providing activities that result in quick liquidity in the market. Some of these activities include buying short-term government bills for temporary funding and permanent financial provision. The BOJ purchases government bonds at regular intervals, which can be sectioned from weeks to months. On the other hand, the federal reserve focuses on selling and buying government treasuries and securities to and from commercial banks to control the money supply through open market operations. Just like the bank of Japan, the federal reserve uses multiple price auction plans.
Furthermore, the market operations are conducted through the domestic trading desk, just like BOJ uses the same strategy. Suppose the Federal Reserve intends to increase the money supply in the market; it buys government securities from commercial banks, thus providing an adequate fund that allows lending banking services. When the federal reserve desires to reduce the money supply, it sells the government securities to national banks.
Reserve Requirement
Both the federal reserve and the Bank of Japan use a monetary policy that demands commercial banks to deposits a certain amount in each country's specific central bank. The amount is calculated in the form of a ratio based on the commercial banks' total deposits. The Federal reserve rarely uses this approach to regulate the money supply; however, it is an effective strategy. When there is an increase of money in the market, the federal reserve increases the reserve requirement ratio against the commercial banks' deposits. Consequently, since there is a reduction of funds within commercial banks, they conduct minimal lending services, reducing the monetary market supply. Similarly, the Bank of Japan executes the same actions to regulate the money supply.
Discount Rates
The federal reserve and Bank of Japan act as the lender of last resort in their specific countries. They grant loans to commercial banks when other options are not available. The discount rate is the interest rate that national banks are required to pay to the central bank. Many central banks, including BOJ and the federal reserve, have adopted discount rates as a monetary policy to regulate the money supply. Both BOJ and federal reserve increase or lower the discount rates to increase or reduce the money supply. For instance, when the BOJ wants to reduce the money supply, it increases the discount rate making the loan expensive for commercial banks. As a result, most banks are not induced to take the loan. Therefore, they limit their lending services due to decreased sources of funds.
Comparison of Banking Regulations Between BOJ and Federal Reserves
The structure and banking regulations of Federal Reserves and BOJ share some similarities. For instance, the two monetary authorities have a selected committee responsible for monetary policy decision-making. The federal reserve committee consists of twelve members, while the BOJ has nine people. Additionally, the two central banks exercise autonomy and independence. As a result, the decision-making process is not influenced by government and politics. The federal bank reserve has multiple goals and responsibilities, including promoting maximum employment and enhancing price stability. Similarly, the Bank of Japan has various duties, which include price stability and financial system stability. Both systems acknowledge that the inflation rate should not exceed two percent to maintain stable market prices (Cargill, 2017).
However, BOJ and federal reserve possess some differences in their banking structures and regulations. The two differ on monetary policy strategy because the federal reserve focuses on economic forecasts and utilizes the projected statistics to maximize the expected positive outcome and deviate from adverse consequences. Therefore, the Federal Reserve has the advantage of preparing and planning effective strategies to overcome a possible threat. On the other hand, the BOJ focuses on short-term inflations projects; therefore, the main goal is to maintain a low inflation rate.
Conclusion
In conclusion, both BOJ and federal banks have illustrated a positive performance based on their specific countries' macroeconomics conditions. These results can be attributed to the fact that the two entities apply almost similar tools and strategies to conduct their operations. However, both can learn a lesson from each other. Based on the findings, it is clear that the federal reserve has helped the USA maintain a strong economy; however, it still has some weaknesses, especially in the unemployment sector. Therefore, the federal reserve should adapt BOJ strategies to increase the employment rate through fiscal policies that allow the government to increase its spending in creating public projects. Additionally, there is a noticeable difference between Japan's and American's GDP. Japan needs to learn appropriate strategies to maximize its market potential by not focusing too much on maintaining a shallow inflation rate. A low inflation rate may limit the economic expansion, which is signified through a low GDP record.
References
Cargill, T. F. (2017). The Federal Reserve in the Shadow of the Bank of Japan. Vol. 33(Spring 20), pages 47-62.
Cavallo, A. (2020). Inflation with COVID-19 consumption baskets (No. w27352). National Bureau of Economic Research.
Chaudhuri, R. R. (2018). Japan. In Central Bank Independence, Regulations, and Monetary Policy (pp. 255-277). Palgrave Macmillan, New York. Https://doi.org/10.1057/978-1-137-58912-5_10
Komlos, J. (2021). The Actual US Unemployment Rate in 2019 Was Twice the Official Rate and the Phillips Curve. Challenge , 1-24.
