An Exception that Proves the Rule:
Japanese Monetary Policy under the Classical Gold Standard,
1897–1914

Shinji Takagi
Distinguished Professor, Asian Growth Research Institute
Professor Emeritus of Economics, Osaka University

Working Paper Series Vol. 2024-11
April 2024

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not necessarily reflect those of the Institute.

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quotations embodied in articles and reviews. For information, pleasewrite to the Institute.

Asian Growth Research InstituteApril 2024

An Exception that Proves the Rule:
Japanese Monetary Policy under the Classical Gold Standard, 1897–1914
Shinji Takagi, Ph.D.
Distinguished Professor, Asian Growth Research Institute
Professor Emeritus of Economics, Osaka University
takagi@econ.osaka-u.ac.jp

Abstract:
The paper explores Japanese monetary policy under the classical gold standard (1897–1914),
while providing a succinct exposition of the distinguishing features of the Japanese gold
standard regime. The paper, explaining how the Bank of Japan conducted monetary policy,
finds that, as a general practice, (i) it used fiduciary issues to offset movements in monetary
gold so as to stabilize the supply of currency; (ii) it moved the discount rate in the same
direction as the government moved the extra issue tax rate; and (iii) it raised the discount rate
in response to an increase in gold outflows. The rules-of-the-game-like behavior of discountrate policy, motivated by the central bank’s mandate to preserve gold convertibility, wasrobust and consistent, challenging the semi-consensual view that violations of the rules were
frequent and pervasive under the classical gold standard.

Keywords: classical gold standard; rules of the game; Japanese monetary policy; Japan under
the classical gold standard; Bank of Japan discount rate policy
JEL classification: F33, F55, E42, E58

The author thanks, without implicating, Erbiao Dai, Masayoshi Honma, Yi-Chun Ko, andYushi Yoshida for their insightful comments on an earlier draft. This research was supported
by Japan Society for the Proportion of Science Grant-in-Aid for Scientific Research(KAKENHI) grant number 22K01590.

2
1. Introduction
This paper explores Japanese monetary policy under the classical gold standard(1897–1914). It is largely a descriptive study in the sense of explaining how monetary policy
was conducted. It does not assess whether the policies pursued achieved the intended
objectives or whether policies were conducted optimally (cf. Giovannini 1986). Japan was on
the gold standard twice: from October 1, 1897 to September 12, 1917 and from January 11,
1930 to December 13, 1931. Our focus is on the classical period. The outbreak of World War
I prompted major European countries to suspend the export of gold, which explains our
choice of July 1914 as the terminal date for this study, though Japan remained on gold forthree more years. 1 Little information is available in the English language on Japan’s
experience with the gold standard. A subsidiary purpose of this paper is to provide a succinct
exposition of the distinguishing features of the Japanese gold standard regime.
Part of our discussion addresses the question of whether the Bank of Japan followed
the rules of the game. The presumed rules are an invention of the interwar period to describe
an idealized working of the classical gold standard. There is therefore no presumption that the
Bank of Japan knew, much less followed, such rules. As generally interpreted (Keynes 1931;
Bloomfield 1959; Triffin 1964; Eichengreen et al. 1985), 2 the rules of the game relate to the
supposed practice of central banks to amplify the impact of a gold flow on the monetary base,so as to subordinate domestic stability to external balance. In an idealized working of theclassical gold standard, it was assumed that a central bank losing (gaining) gold (i) raised

1

Because Japan could no longer import gold, the yen–sterling exchange rate routinely moved

outside the presumed gold import point during World War I.
2

McKinnon (1993) offers an unconventional interpretation that highlights how central banks

managed the gold standard as a monetary arrangement.

3(cut) the discount rate to encourage a capital inflow (outflow) or (ii) sold (purchased)
domestic securities to contract (expand) the monetary base further.
The rest of the paper is organized as follows. Section 2 describes the legal
underpinning of the Japanese gold standard and how the money supply rule was specified.
Section 3 discusses the unique manner in which Japan’s monetary authorities stabilized theexchange rate around the gold parity, while section 4 highlights the operation of the specie(specie-convertible foreign exchange) balances kept abroad for that purpose. Sections 5 and 6
provide an empirical analysis of how the Bank of Japan conducted monetary policy, with thelatter focusing on the question of whether it followed the rules of the game. Section 7
explains how the central bank’s discount rate policy produced a rules-of-the-game-likepattern. Finally, section 8 presents a conclusion.
2. The money supply rule
The Coinage Law (Kahei Hō) of 1897 defined one yen as 0.75 gram of pure gold. The
British pound was the Bank of Japan’s reference currency. The yen’s exchange rates against
other currencies, including the U.S. dollar, were derived as cross rates from their values
against the pound. Because a pound was valued as equivalent to 113 grains of pure gold, theyen’s parity was approximately ¥9.7632 per pound; likewise, with a dollar valued as
equivalent to 23.22 grains of pure gold, the parity was approximately ¥2.0062 per dollar. By
convention, the yen–pound rate was expressed in terms of shillings per yen, and the yen–dollar rate in terms of dollars per ¥100, so the parities were approximated as 2s 0.582d (or24.582d) and $49.846, respectively.
A range of estimates were given by contemporary observers for gold points (e.g.,
Kimura 1926; Fujita 1929; Mimata 1929). Against the dollar, the estimates ranged between$50.1875 and $50.375 (per ¥100) for the import point and between $49.3125 and $49.5 forthe export point, suggesting a margin of up to 1 percent on either side. A somewhat wider

4
margin of around 1.2 percent was suggested for the yen–pound rate, reflecting the longer timerequired for gold to travel to and from London. 3 Shipping gold involved the costs of freight,
insurance, and interest, which varied considerably across time and individuals, meaning thatthe actual gold points were highly variable. Even though very little private shipment of gold
took place in practice, the presumed gold points, and the real threat of gold shipment, dictated
how foreign exchange rate policy was conducted.
Stipulated by the Convertible Bank Notes Ordinance (Dakan Ginkōken Jōrei) of
1884, as revised in connection with the Coinage Law, the money supply rule was called the“elastic fiduciary issuance limit method (hoshō hakkō kusshin seigen hō).” The supply ofbank notes consisted of (i) “specie issues” (seika hakkō), (ii) “fiduciary issues” (hoshō
hakkō), and (iii) “extra issues” (hoshōgai hakkō). The Bank of Japan was, first and foremost,required to hold specie equivalent in value to the balance of notes outstanding. Second,fiduciary note issues, unbacked by specie, were permitted up to a statutory limit against the
security of government or high-quality commercial securities, in order to accommodate thepublic’s variable demand for currency. The initial fiduciary limit of ¥85 million, inheritedfrom the silver standard era, was raised to ¥120 million in March 1899. This amountremained unchanged until 1932, following Japan’s permanent departure from gold.
Third and finally, the central bank, under extraordinary circumstances, could issue
additional notes by obtaining approval from the minister of finance and by paying a tax of notless than 5 percent per year, as determined by the minister. The purpose of the extra issue tax
was to serve as a warning signal to prompt the central bank to take remedial action (Tanaka

3

These may be compared to the average margins of about 0.42 percent (exports) and 0.31

percent (imports) during 1901–10 for U.S.-based London–New York arbitrageurs, asestimated by Officer (1996).

51929). Implicit was the idea that (i) the supply of notes must ideally be anchored in the stockof specie, so that extra issues should be withdrawn as soon as practical; and (ii) the Bank ofJapan, as a joint stock company, was not free from a profit motive. The intent was to induce
the Bank of Japan to raise the discount rate whenever the government raised the extra issue
tax in order to reduce the public’s demand for currency. The contemporary statement ofsenior officials indicates that the extra issue tax was binding on their decisions. 4
3. The mechanism of fixing the exchange rate
Japan’s experience with the gold standard was not a textbook case. Gold coinage saw
limited circulation, in part owing to the large minimum denomination of ¥5, when Japan’sannual per capita GNP in 1900 was about ¥55 (Ohkawa et al. 1974). The public’s confidence
in the central bank’s pledge of gold convertibility was such that almost all cash transactions
took place in the form of currency notes. Externally, the monetary authorities (comprising theministry of finance, the Bank of Japan, and, in some cases, their agent, the Yokohama SpecieBank) did not maintain the gold parity through the free private movements of gold. Instead,they managed the gold standard largely by selling and buying foreign exchange held abroad
at a fixed rate, which they typically set below the parity but above the presumed gold export
point ostensibly to encourage exports and discourage imports (Furuya 1928).

4

Eigo Fukai (1938, p. 268), whose long and distinguished central bank career included

tenures as deputy governor (1928–) and governor (1935–37), states that it was “painful” forthe Bank of Japan as a private, for-profit institution to purchase foreign exchange when thefiduciary limit was reached. Unless the government allowed the foreign exchange to be
counted as part of the monetary gold reserve, purchases of foreign exchange under suchcircumstances would entail a considerable cost as the extra issue tax was greater than any rateof return it could expect to earn from investing the funds in liquid assets abroad.

6
The practice of using foreign exchange to maintain the peg emerged as experience
was gained and proved to be an efficient arrangement for traders and financiers located far
away from each other. 5 It took gold at least 20 days to travel between Yokohama and London
or New York. On top of the costs of transportation and insurance, an annual interest of 6–7
percent, typically, was charged during the transshipment (Inouye 1931; Kojima 1981).
Central bank pegging of the yen with the use of foreign exchange deliverable in London or
New York made sense, both for the authorities who wanted to avoid a physical outflow ofgold, and for market participants who wanted to minimize transactions costs. The systemitself was established in 1904 but the practice of determining the selling rate in relation to thegold export point may have started in 1909 (Kojima 1981).
Japan was by no means unique in this regard. Under the classical gold standard, little
gold movement took place generally (Cassel 1936). Instead of shipping gold, bills of
exchange drawn on London were typically used as a means of international payment.
Although New York, Berlin, and Paris had emerged since 1890 to challenge London’s
dominance, London maintained “her supremacy” in the financing of world trade at least until
the middle of World War I (De Cecco 1984, pp. 105–06). Even Japanese export bills drawn
against Chinese, Indian, or American importers were made payable in London, and Japanese
importers paid for their imports in sterling bills drawn against them payable in London(Furuya 1928). The receipts for silk exports to the United States might be made in sterling in

5

The Bank of Japan remained committed to honoring the obligation to convert currency

notes into gold. Private bankers continued to obtain gold from the Bank of Japan’s gold
window for shipment to Shanghai (Nochi 1981). Of the ¥320 million of gold sold by the
Bank of Japan between 1906 and 1912, about ¥132 million came from the gold window andabout ¥188 million from the overseas specie balances (Kitsukawa 1969).

7
London, which might then be used to pay for the imports of machinery and chemical products
from Germany (Fukai 1929).
The official balances of interest-bearing assets denominated in gold-convertible
currencies (often referred to simply as specie) played a central role in this system. Initially,
these assets were held by the government, with the Bank of Japan acting as a custodian. In
early 1903, the central bank for the first time owned its own foreign assets when it purchasedpart of the ¥50 million proceeds the government had obtained in September 1902 from sellingbonds in London. The central bank kept the funds as a pound deposit amounting to about ¥26
million (Taira 1984). In June 1904, it signed a formal agreement with the ministry of finance,
authorizing it to own foreign balances; the agency agreement was finalized with the
Yokohama Specie Bank in December. The central bank accumulated foreign assets wheneverit purchased them from the government or foreign exchange banks.
Overseas specie balances became a distinguishing feature of the working of Japan’sclassical gold standard. Part of this reflected the government’s need to earmark a portion of
the foreign exchange to the import of weaponry (Nochi 1981). The balances were replenishedfrom time to time by external borrowing. The government kept in London and other financial
centers the portion of the proceeds it did not immediately use. When it wanted to use thefunds in Japan, it sold part of the foreign exchange to the central bank. This is how the Bankof Japan typically came to acquire foreign assets on its own accounts. These government andcentral bank balances were held in liquid but safe assets, normally government securities,
central bank deposits, or deposits with commercial banks of high credit standing.
Given the way the exchange rate was fixed, the yen was more likely on the
depreciated side of the gold parity (Figure 1). Because the pound was the reference currency,
the margins for the yen–pound rate were somewhat smaller than for the yen–dollar rate. Evenso, the difference between the maximum and the minimum in any month never exceeded 1.3

8
percent for either exchange rate from October 1897 to June 1914. With sterling being thereference currency, the yen–pound rate could be fixed for a prolonged period of time. Basedon monthly average data, for example, it was pegged at 2s 4⁄10d for 23 consecutive months(December 1909–October 1911) and 2s 3⁄10d for 16 consecutive months (March 1900–June
1901). The yen–pound rate, therefore, was a policy rate. Japan was by no means unique, as
Cassel (1936, p. 3) observed: no country let “gold movements necessarily influence” theexchange rate, which “depended entirely on the policy of the central bank.”

2.11
2.09
2.07
2.05
2.03
2.01
1.99
Oct-1897
Jun-1898
Feb-1899
Oct-1899
Jun-1900
Feb-1901
Oct-1901
Jun-1902
Feb-1903
Oct-1903
Jun-1904
Feb-1905
Oct-1905
Jun-1906
Feb-1907
Oct-1907
Jun-1908
Feb-1909
Oct-1909
Jun-1910
Feb-1911
Oct-1911
Jun-1912
Feb-1913
Oct-1913
Jun-1914

Shillings per yen

Figure 1. The Yen's Monthly Average Exchange Rate against
the Pound, October 1897–July 1914

Market rate

Gold parity

Export point (per BOJ)

Import point (per BOJ)

Notes: the presumed gold export point of 2.0208 shillings and import point of 2.0729 shillings are based on
Fukai (1941). These are for illustrative purposes only. There is no reason to expect the gold points to haveremained constant throughout the period.
Source: Bureau of Statistics, Teikoku Tōkei Nenkan, annual issues.

4. The management of the overseas specie balances
A change was introduced to the money supply rule in December 1903, when thegovernment authorized the Bank of Japan to count part of its sterling deposits in London as
the backing for specie issues. Additional assets were counted as eligible for backing specie
issues in subsequent years, including British, U.S., and French government securities(Kitsukawa 1969; Kojima 1981). From 1904, the official overseas specie balances therefore
consisted of three components: (i) assets held in the government account; (ii) assets counted
as part of the Bank of Japan’s monetary gold reserve; and (iii) assets held in the Bank ofJapan’s nonmonetary gold account. A question arises as to how each of the three accounts

9
was used by the authorities to transact in foreign exchange, which had different implications
for their impacts on the monetary base.
Government transactions would not change the monetary base when they involved
external borrowing or payments. A government purchase of export bills by means of funds
raised from domestic borrowing amounts to sterilized intervention in which the central bankpurchases foreign exchange while simultaneously selling government securities in the open
market. How much the government could accumulate the specie balances was limited by theavailability of funds at its disposal, while it could only run down the balances until they weredepleted. The government could therefore lack the flexibility to respond quickly if it needed
to raise funds through domestic or foreign borrowing. In contrast, the Bank of Japan could beflexible in purchasing foreign exchange, but its foreign exchange transactions, irrespective ofwhether they involved sales or purchases or whether they operated through the monetary or
nonmonetary gold account, directly affected the monetary base.
The Bank of Japan mainly used the nonmonetary specie balances to conduct foreignexchange transactions as if to protect the assets set aside as the monetary gold reserve. In
order to move funds from the nonmonetary to the monetary gold account, it needed special
authorization from the ministry of finance in each instance (Fukai 1938). When foreignexchange was purchased, it was normally added to the nonmonetary balances, which wasreflected as an increase in fiduciary issues. If the fiduciary limit was binding, it needed torequest the government to authorize the assignment of the foreign exchange to the monetary
gold account. Otherwise, it had to resort to extra issues, which it was generally reluctant to do
because the extra issue tax was higher than any rate of return it could expect to earn byinvesting the funds in liquid assets abroad.
The overseas specie balances were held predominantly in London, with smallbalances in Berlin, New York, and Paris. At the end of FY1914, for example, the majority

10(63.1 percent) was owned by the Bank of Japan, with the predominant portion of it (90.3
percent) in London; no monetary gold was held outside London (Matsuoka 1936). The
government deposits in Berlin, New York, and Paris were meant to facilitate the payment ofinterest on bonds raised in those markets or to pay for the import of weapons from thosecountries (Nochi 1981). Between 1916 and 1917, the war in Europe prompted the Japanese
authorities to shift more of the specie balances to New York, while consolidating in London
the small balances held in Berlin and Paris (Tomaru 1932).

100

250

80

200

60

150
40

100
50

20

0

0

Percent

300

1897
1898
1899
1900
1901
1902
1903
1904
1905
1906
1907
1908
1909
1910
1911
1912
1913
1914

Millions of yen

Figure 2. Components of Japan's Monetary Gold
Balances, 1897–1914 (In millions of yen; percent of
total)

Domestic

Overseas

Overseas (% total; right scale)Note: “Domestic” reserves were held in gold and “overseas” reserves in gold-convertible foreign exchange.
Source: Bank of Japan (1986), pp. 332–34.

Japan’s gold standard was often characterized as a gold-exchange standard, in which
the central bank uses foreign exchange to manage the system (Matsuoka 1936; Ishibashi1936), a practice that became wide-spread following the Genoa Conference of 1922. The
uniqueness of this practice under the classical gold standard should not be exaggerated.
League of Nations (1944) noted that, in 1913, fifteen European central banks held about 12
percent of gold reserves in the form of foreign exchange. If there was any sense in which theJapanese system was unique, it was the considerably higher share of foreign exchange inJapan’s “gold” reserves compared to other countries (Figure 2). At its peak in 1906, the share
was as much as 83.7 percent. The same publication classified Japan, along with Argentina,
India, and Russia, as uniquely practicing a sterling exchange system.

11
Fukai (1941) did not share such a view. Referring to Keynes’s (1913) description of
the Japanese system as “virtually the same in practice” as the one in India (pp. 33, 35–36),
Fukai argued that the Bank of Japan was obligated to, and did in practice, convert bank notes
into specie, for which it maintained a large domestic stock of gold, and that the gold points(which presupposed the shipment of gold) dictated the terms at which the central banktransacted. The use of foreign exchange was a target of constant criticism as a violation of thespirit of the Coinage Law (Ishibashi 1932), which caused the authorities to become opaqueabout the overseas balances (Kitsukawa 1969). The government did not disclose, even to theDiet, the breakdown that would allow the amount of central bank nonmonetary gold to be
known. The central bank predominantly used nonmonetary gold to conduct foreign exchange
operations, at least in part, to conceal the volatility of specie movements (Kojima 1981).
5. Aspects of Monetary policy under the gold standard
Rules vs. discretion
Figure 3. The Growth of the Components of Convertible Note
Issues, October 1897–July 1914 (In millions of yen)Oct-1897
May-1898
Dec-1898
Jul-1899
Feb-1900
Sep-1900
Apr-1901
Nov-1901
Jun-1902
Jan-1903
Aug-1903
Mar-1904
Oct-1904
May-1905
Dec-1905
Jul-1906
Feb-1907
Sep-1907
Apr-1908
Nov-1908
Jun-1909
Jan-1910
Aug-1910
Mar-1911
Oct-1911
May-1912
Dec-1912
Jul-1913
Feb-1914

600
500
400
300
200
100
0

Specie issues

Fiduciary issues

Extra issues

Source: Asakura and Nishiyama (1974), pp. 291–313.

During the classical period, the balance of convertible notes expanded by 1.7 times;
specie-backed issues increased by 2.4 times, with the specie cover ratio rising from 45.2 to65.4 percent. The average ratio was 50.7 percent, with the maximum of 78.5 percent (May1910) and the minimum of 29.2 percent (December 1904). The statutory limit for fiduciaryissues remained unchanged from March 1899 even though the size of the economy grew by12about 40 and 140 percent, respectively, in real and nominal terms. This explains why the limit
frequently was almost fully utilized (Figure 3), with the average utilization of 95.2 percent.
The supply of convertible notes was augmented by extra issues in 117 out of the 202 months,
making the sum of fiduciary and extra issues to average 111.5 percent of the fiduciary limit.
The Bank of Japan liberally used the fiduciary and extra issue provisions to supply currency
beyond the stock of available gold.
Table 1. Monthly Standard Deviations and Correlations of Components of the Monetary Base,
October 1897–July 1914
October 1897
(1898)–December
1904 (N=87/75)
Log
Log diff.
Notes
Specie issues
Fiduciary &extra issues
Extra issues

0.097
0.202

0.112
0.281

0.180
4.775

0.257
6.927

January 1905–July
1914 (N=115)

June 1909-July 1914
(N=62)
Log diff.

October 1897
(1898)–July 1914
(N=202/190)
Log
Log diff.

Log
Log diff.
Standard deviations:
0.129
0.085
0.253
0.129

Log
0.093
0.039

0.059
0.117

0.251
0.426

0.097
0.205

0.238
0.244
4.549
5.186
Correlations:

0.248
4.946

0.253
5.661

0.229
4.762

0.249
5.918

Notes/specie
issues0.438**
0.358**
0.742**
0.163* 0.350**
0.097 0.961**
0.290**
Notes/fiduciary& extra issues
0.609**
0.572**
0.301**
0.677** 0.946**
0.562** 0.480**
0.615**
Specie/fiduciary& extra issues-0.401** -0.503** -0.401** -0.549**
0.041 -0.696**
0.088 -0.493**
Specie/extra
issues-0.474** -0.660** -0.404** -0.479**-0.029-0.685**-0.036-0.571**
Notes: log difference=12-month difference in natural logarithm, roughly interpreted as annual percentagechange; **(*) indicates that the correlation coefficient is significant at 1(5) percent; when the balance of extra
issues is zero, it is set to equal one (so that its logarithmic value is zero).
Source: author’s calculations based on Asakura and Nishiyama (1974), pp. 291–313.

In exploring factors that may have influenced the Bank of Japan’s conduct ofmonetary policy, we divide the sample into two periods: October 1897–December 1904 andJanuary 1905–July 1914. The break point is somewhat arbitrary but informed by the fact that,as previously noted, the Bank of Japan started to manage its own overseas specie balances
sometime during 1904. Calculating the standard deviations and correlations of various
components of the convertible note issue (expressed in level and as a year-on-year percentage

13change to remove seasonality), 6 we observe two important patterns (Table 1). First, thestandard deviations of overall convertible notes were about half the size of those of either
specie issues or fiduciary plus extra issues (the large size of the standard deviations of extra
issues reflects the fact that they could take the value of zero).
Figure 4. Annual Growth in the Components of Convertible
Notes, October 1898–July 1914 (In percent, yoy)Oct-1898
May-1899
Dec-1899
Jul-1900
Feb-1901
Sep-1901
Apr-1902
Nov-1902
Jun-1903
Jan-1904
Aug-1904
Mar-1905
Oct-1905
May-1906
Dec-1906
Jul-1907
Feb-1908
Sep-1908
Apr-1909
Nov-1909
Jun-1910
Jan-1911
Aug-1911
Mar-1912
Oct-1912
May-1913
Dec-1913
Jul-1914

100
80
60
40
20
0
-20
-40
-60
-80

Monetary gold

Fiduciary & extra issues

Convertible notes

Note: obtained as 12-month differences in natural logarithm.
Source: author’s calculation based on Asakura and Nishiyama (1974), pp. 291–313.

Second, as a corollary to the first, specie issues had a significantly negative
correlation with fiduciary plus extra issues. The negative correlation was more pronounced
when expressed as an annual percentage change (Figure 4). Combined with the previous
observation, this implies that the Bank of Japan used fiduciary plus extra issues to offset
movements in monetary gold (called “neutralization” policy in the literature). From around
June 1909, 7 specie issues became a stable part of the note issue and the specie cover ratio
never fell below 50 percent. The Bank of Japan almost entirely used fiduciary plus extra

6

Natural logarithms are used to ensure that the statistics are independent of scale.

7

The balance of monetary gold reached ¥200 million and the specie cover ratio peaked at

78.5 percent in the previous month, intimating that the central bank might have been
purposely accumulating monetary gold up to that point.

14
issues to accommodate changes in the demand for currency while keeping the balance ofmonetary gold stable during the rest of the classical period.
Extra issue tax
As initially designed, extra issues were an extraordinary measure that needed to bewithdrawn as soon as practical. In order to induce the Bank of Japan to do so, the minister offinance was supposed to raise the extra issue tax whenever the public’s demand for currency
increased beyond the fiduciary limit. This was thought to prompt the central bank to raise thediscount rate, which would in turn reduce the public’s demand for currency. A change in theextra issue tax rate did not always precede a change in the discount rate. The government
sometimes raised the tax rate to incentivize the central bank to maintain the discount rate at
an elevated level. The Bank of Japan, on its part, sometimes raised the discount rate
preemptively when the fiduciary limit was about to be reached (Tanaka 1929).

100

8

80

7

60

6

40

5

20

4

0

Millions of yen

9

Oct-1897
Jul-1898
Apr-1899
Jan-1900
Oct-1900
Jul-1901
Apr-1902
Jan-1903
Oct-1903
Jul-1904
Apr-1905
Jan-1906
Oct-1906
Jul-1907
Apr-1908
Jan-1909
Oct-1909
Jul-1910
Apr-1911
Jan-1912
Oct-1912
Jul-1913
Apr-1914

Percent

Figure 5. The Discount Rate, the Extra Issue Tax Rate, andExtra Issues, October 1897–July 1914 (Percent per year;
millions of yen)

Extra issues (right scale)

Discount rate

Extra issue tax

Sources: Asakura and Nishiyama (1974), pp. 291–313; Bank of Japan (1986), pp. 356, 374; Goto (1970), p. 6.

The system clearly functioned as envisioned through 1902 (Figure 5), with acorrelation coefficient of 0.72 between the extra tax rate and the discount rate. The
relationship subsequently weakened as the tax rate remained unchanged at 5 percent. The
relationship reemerged on January 6, 1913, when a tax rate increase (from 5 to 6 percent)15
reenforced the increase in the discount rate. The weaker relationship after 1903 may meanthat the Bank of Japan was adjusting the discount rate in response to the direction of change
in the balance of extra issues (Tanaka 1929), so as to minimize the payment of the tax. Thatis, it cut (raised) the discount rate when the balance of extra issues was declining (increasing).
If so, the tax was binding on discount rate policy even when the tax rate was not changed.
6. Did the Bank of Japan Follow the Rules of the Game?
The influential works of Ragnar Nurkse and Arthur Bloomfield likely contributed tothe semi-consensual view that violations of the rules of the game were pervasive under thegold standard (League of Nations 1944; Bloomfield 1959). For the interwar period (1922–38), Nurkse came to this conclusion by finding a negative correlation, in annual data,
between foreign and domestic assets in central bank balance sheets about 60 percent of thetime in 26 countries, which included Japan. 8 Bloomfield, applying Nurkse’s methodology to
the classical period (1880–1914), found the failure to follow the rules not specific to theinterwar period: the correlation was negative about 60 percent of the time in 11 countries. A
replication by Teranishi and Uchino (1986) yielded a similar finding for Japan during 1897–
1914, namely, foreign and domestic assets were negatively correlated 65 percent of the time.
Some have questioned why a negative correlation between foreign and domestic
assets in and of itself should be taken as conclusive evidence (Yeager 1966). 9 When a loss ofgold leads to a contraction of currency, it is difficult to imagine that the central bank would

8

Japan was on the gold standard during only two years (1930–31) of the sample period. The

correlation for Japan was found to be negative from 1927 to 1933 and for 1923 and 1936.
9

Yeager (1966, p. 288) notes: “the apparent neutralization may often have been ‘automatic’… Mere passive response to credit demands … could have made a central bank’s domestic
and international assets move in opposite directions.”

16
be so unwilling to accommodate at least part of the existing demand for currency that it
would not allow the holding of domestic assets to increase even by a small amount. Such a
presumption is similar, though not identical, to the operation of Bagehot’s Rule, which
McKinnon (1993) considers to be part of the rules of the game. 10 At least in the short run, it
makes more sense to think of the rules of the game as implying that a change in foreign assets
is not fully offset by an opposite change in domestic assets (Jeanne 1995). In the longer run,when a higher discount rate could reduce the demand for currency, the rules of the game
could be consistent with a positive correlation between foreign and domestic assets.
In view of the endogenous nature of domestic assets, the present study uses thediscount rate as a less ambiguous measure of central bank action. Recent empirical literature,by estimating a discount rate reaction function, shows that central banks in the European
periphery adjusted the discount rate to keep the gold cover ratio (Morys 2013). Evidence forcentral banks in the European core is mixed. A discount rate was raised in response to a
decline in monetary gold in Britain and Germany (Giovannini 1986; Davutyan and Parke
1995), but not in France (Bloomfield 1959). Discount rate policy in Britain, Germany, andFrance may have been used more to stabilize the exchange rate (Morys 2013). The Bank ofEngland’s discount rate policy was nuanced, given that it was also responding to domestic
economic conditions (Jeanne 1995).
The present study does not follow this literature to estimate a discount rate reaction
function by postulating a set of explanatory variables. As discussed in the following section,
the contemporary writings of senior central bankers, and the government’s instructions to the10

McKinnon (1993, p. 9–10) states: “Nurske’s supposed ‘rule’ conflicts directly with

Bagehot’s well-established operating principle … But this positive association is not itself a‘rule’ [but] an endogenous response to an increase in the domestic demand for money.”

17
central bank, make it clear that the Bank of Japan used discount rate policy almost
exclusively to preserve gold convertibility: it raised the discount rate when there was anincrease in gold outflows. We simply test this hypothesis. The remaining issue is to determine
which measure of gold movements (monetary gold alone vs. monetary and nonmonetary gold
combined) discount rate policy was targeting (government-owned specie movements are
excluded because they largely reflected foreign borrowing or purchases of foreign goods).
We maintain that the Bank of Japan was more likely responding to monetary gold
movements, which it considered to be a permanent component of its specie holdings.
The hypothesis that the Bank of Japan followed the rules of the game is formallytested by regressing a percentage-point change in the discount rate over a percentage change
in the balance of monetary gold, with a constant and possibly one or two additional
explanatory variables (Table 2). The percentage change is approximated as an annual
logarithmic difference to remove any seasonality and to ensure scale independence. We use
period-end monthly, quarterly, and annual data (specifications 1, 2, 3 in Table 2). In themonthly and quarterly specifications (1, 2), the one-period lagged dependent variable isincluded, both to correct serial correlation and to account for the initial value (on which thedecision concerning an incremental change in the discount rate must have depended).
Two specifications (1* and 2*) include the Bank of England’s Bank Rate (expressedas an annual percentage-point change). Literature suggests evidence that the Bank ofEngland’s Bank Rate typically led the discount rates in other countries (Eichengreen 1987),
that discount rates in the European periphery were significantly influenced by the British or
German rate (Morys 2013), and that the discount rates of virtually all central banks tended tomove together (Bloomfield 1959). This is not to presume that Japan was part of thisfinancially integrated world, but only to account for the possible influence of Bank Rate on
global gold movements. In annual data, specification 3* uses the central bank’s total

18(monetary and nonmonetary) gold holdings as a measure of gold movements. The breakdownof the overseas specie balances by location and ownership was only available annually.
Table 2. Ordinary Least Squares Estimates of the Discount Rate Reaction to Monetary Gold
Movements, 1897–1914 1
Specifications2
Dependent
variable (Dep.
var.)
Independent
variable ofinterest
ChangeData frequency
Ind.
Current
var.3

1*

2
2*
3
3*
Bank of Japan discount rate, percentage-point change

45MonthlyMonthly-0.006*(0.003)0.000(0.003)-0.006*(0.003)-0.009**(0.003)

Quarterly
Quarterly-0.011(0.005)-0.012**(0.005)

Monetary gold, current and lagged values

Annual (12-month; 4-quarter)
Quarterly
Quarterly
Annual-0.019**-0.018**-0.041**(0.005)(0.006)(0.011)Monthly-0.004*(0.002)Monthly-0.004*(0.002)

Lag 1

-

-

-

-

-

-

Lag 2

-

-

-

-

-

-

Lag 3

-

-

-

-

-

-

-

-0.037(0.034)--0.077(0.080)

-

-

-

-

-

0.075*(0.033)

-

-

-

-

-

-

0.922**(0.027)189
0.92(0.92)
1131.97**(0.000)1.560

0.932**(0.028)189
0.93(0.92)
577.93**(0.000)1.600

0.648**(0.085)620.75(0.74)
88.19**(0.000)1.563

0.643**(0.085)620.75(0.74)
59.03**(0.000)
1.497

-

-

-

-

17
0.46
(0.42)
12.81**(0.003)
2.404

17
0.51
(0.48)
15.78**(0.001)
1.954

198
0.09
(0.08)
5.04**(0.001)
1.877

65
0.12
(0.10)
4.37*(0.016)
1.689

Bank
Rate
Bank
Rate
(-1)
Dep.
var. (-1)
NOB
R-squared(Adjusted)
F-statistic4
DW

1

Annual-0.038**(0.010)-Notes: 1- indicates “not available,” **(*) indicates statistical significance at the 1(5) percent level; 2 3* uses movements intotal gold, not just monetary gold; 3 standard errors in parentheses; 4 p-values in parentheses.
Source: author’s estimates based Asakura and Nishiyama (1974), pp. 291–313; Bank of Japan (1986), pp. 356, 374,
supplemented by www.boj.or.jp; Federal Reserve Bani of St. Louis (https://fred.stlouisfed.org).

We are only interested in the sign of the coefficient of gold movements (thediscussion of the impact of Bank Rate is deferred to the following section). In all
specifications, the sign is negative and statistically significant at the 1 or 5 percent level. In
annual frequency, the use of monetary gold alone or total gold holdings makes no difference.
The goodness of fit is high, with the R-squared of 0.92 in monthly data and 0.75 in quarterly
data. As a robustness check, we ran the same regressions using monthly and quarterly
percentage changes (appropriated by logarithmic differences) and replacing the lagged
dependent variable with lagged monetary gold movements (to account for the likelihood that,in higher frequency, the central bank reacted to both current and lagged gold movements).

19
The goodness of fit worsens, but the sign of the coefficient(s) remains negative andstatistically significant at the 1 or 5 percent level (specifications 4–5).
Table 3. Granger Causality Tests of Monetary Gold Movements and the Discount Rate,
1897–1914
Specification
1
2
3
4

Data
frequency
Monthly
QuarterlyMonthly
Quarterly

Causality
From
To
Gold movements Discount rate
Discount rate

Gold movements

Lag length
6565F-statistic (pvalue)
2.36* (0.033)
4.35** (0.003)
4.11** (0.001)
3.13* (0.016)

Notes: annual percentage changes in monetary gold approximated as 12-month differences in natural logarithm;
12-month percentage-point change in the discount rate; leg length obtained by AIC; **(*) indicates that the null
hypothesis of no causality is rejected at the 1(5) percent level.
Sources: author’s estimates based on Asakura and Nishiyama (1974), pp. 291–313; Bank of Japan (1986), pp.
356, 374.

Percentage point

4
3
2
1
0
-1
-2
-3
-4

80
60
40
20
0
-20
-40
-60
-80
Oct-1898
Jul-1899
Apr-1900
Jan-1901
Oct-1901
Jul-1902
Apr-1903
Jan-1904
Oct-1904
Jul-1905
Apr-1906
Jan-1907
Oct-1907
Jul-1908
Apr-1909
Jan-1910
Oct-1910
Jul-1911
Apr-1912
Jan-1913
Oct-1913
Jul-1914

Percent

Figure 6. Monetary Gold and the Discount Rate, October 1898–
July 1914 (In changes over 12 months)

Growth in monetary gold
Percentage point change in the discount rate (right scale)Notes: annual percentage changes in monetary gold approximated as 12-month differences in natural logarithm;
12-month percentage-point change in the discount rate.
Sources: author’s calculations based on Asakura and Nishiyama (1974), pp. 291–313; Bank of Japan (1986), pp.
356, 374.

In order to ascertain that causality runs from monetary gold movements to discountrate changes, we have performed Granger causality tests using both monthly and quarterly
data (Table 3). We find evidence of Granger causality in the right direction, confirming thatthe discount rate was responding to monetary gold movements. At the same time, there wasalso evidence of reverse causality. This is to be expected. A change in the discount rate was
supposed to reverse the direction of gold movement. When the underlying data for
specification 1 (in Table 2) are depicted (Figure 6), we see that the Bank of Japan typically20raised the discount rate when the balance of monetary gold was declining, and vice versa, but
the negative relationship between the two evidently weakened after 1911.
7. Explaining Bank of Japan Discount Rate Policy
The central bank discount rate policy that appeared to follow the rules of the gamecan be explained by the overriding objective of monetary policy, that is, to preserve gold
convertibility. In June 1897, just prior to the institution of the gold standard in October, theBank of Japan was instructed by the minister of finance to take various measures, including
an increase in the discount rate, “when an adverse turnaround in the trade balance leads to an
outflow of gold” (Bank of Japan 1984, pp. 24–25). Junnosuke Inouye (1925, 1926), two-timegovernor of the Bank of Japan (1919–23; 1927–28) whose central bank career had begun in
1896, stated that the central bank’s monetary policy had the twin objectives of (i) preserving
gold convertibility and (ii) moderating domestic credit conditions, and that the discount rate
was the only available policy tool.
Rarely did these objectives conflict with each other. An overheating economy, forexample, was generally associated with easy money, which caused imports to rise and gold toflow out. A typical response in such cases was to raise the discount rate. There is no evidence
that the Bank of Japan cut the discount rate in response to a gold inflow (which seldom
happened). The observed negative relationship between gold movements and discount ratechanges was generated by a reversal of tight monetary policy, not necessary a cut in the
discount rate in response to a gold inflow. 11 A detailed, episode-by-episode analysis of
discount rate changes show that the central bank typically raised the discount rate when a11Such asymmetric response was observed in other central banks (Bloomfield 1959),

including the Bank of England (Davutyan and Parke 1995).

21
trade deficit caused an outflow of gold and reversed the action when the outflow dissipated(Takizawa 1912; Ishibashi 1936; Takesawa 1968).
The negative relationship between discount rate changes and monetary gold
movements is, in part, reflective of the negative relationship we have observed between the
discount rate and the extra issue tax rate, given the negative correlation between specie andextra issues (see Table 1, bottom row). This can be understood in the following way. Supposethat a trade deficit causes gold to flow out, contracting the balance of specie issues. Suppose
also that the Bank of Japan is operating at close to the fiduciary issue limit. Then, the central
bank must either retire loans or resort to extra issues. Given that, in the very short run, it
cannot retire loans quickly, it must accommodate at least part of the existing demand for
currency by supplying extra issues. This is the mechanism by which a trade deficit, through agold outflow, could increase extra issues. In order to minimize the payment of the extra issuetax, the Bank of Japan raised the discount rate to reduce the demand for its credit.
Japan’s central bankers held the view that a change in the discount rate influenced
gold movements primarily through its impact on trade, unlike the case in the U.K. where
capital flows constituted the primary channel (Bank of Japan 1984). Inouye (1926)
emphasized that the Bank of Japan, in raising the discount rate, did not expect to retain, muchless attractive, foreign capital, but expected the impact to work through discouraging imports.
Inouye (1925), in his exposition of monetary policy, went so far as to say that the Bank ofJapan, in fulfilling its mandate to preserve gold convertibility, raised the discount rate
whenever imports surged and reversed the policy when the trade deficit narrowed.
A robust relationship between trade and gold movements is corroborated in monthly
data from 1898 to 1914: monetary gold movements typically followed changes in the tradebalance with a lag of 2–6 months (Table 4). The negative relationship between discount ratechanges and monetary gold movements found in Table 2 could be replicated by regressing

22
the discount rate on the trade balance, where both are expressed as annual changes (Table 5).
The sign of the coefficient of the trade balance (current and 3-month lagged) is negative andstatistically significant at the 1 or 5 percent level.
Table 4. Monthly Correlations of Changes in the Trade Balance and Monetary Gold, October 1898–
July 1914 (N=190)
Change in tradebalance (t)tt+1Change in monetary gold
t+2
t+3
t+4

0.02

0.10

0.14*

0.23**

0.23**

t+5

t+6

0.23**

0.20**

Notes: **(*) indicates statistical significance at the 1(5) percent level; annual percentage changes approximated as 12-monthnatural logarithmic differences; the trade balance rescaled by adding a constant to make the minimum equal to +1.
Sources: author’s calculations based on Tōyō Keizai Shinpōsha (1935); Asakura and Nishiyama (1974), pp. 291–313.

Table 5. Ordinary Least Squares Estimates of the Discount Rate Reaction to Changes in the Trade
Balance, October 1898–July 1914 1
Specifications
Ind. var. 2

1
2-0.0016** (0.0006)-0.0018** (0.0005)-0.0006 (0.0006)+0.0007 (0.0007)-0.0013* (0.0006)-0.0011* (0.0005)+0.936** (0.020)+0.936** (0.020)
NOB
187
187
R2 (adjusted-R2)
0.933 (0.932)
0.933 (0.932)
F-statistic 4506.9 (0.000)
844.3 (0.000)
DW
1.665
1.682
Notes: 1 – indicates “not available”; 2 standard errors in parentheses; 3 the trade balance rescaled by adding a
constant to make the minimum equal to +1; 4 p-values in parentheses.
Source: author’s estimates based on Tōyō Keizai Shinpōsha (1935); Bank of Japan (1986), pp. 356, 374.
Current trade balance (t) 3
Lagged trade balance (t-1) 3
Lagged trade balance (t-2) 3
Lagged trade balance (t-3) 3
Lagged dep. Var. (t-1)

There is no episodic evidence that the Bank of Japan systematically responded to the
Bank of England Bank Rate. The Bank of Japan discount rate was perennially higher, on
average by 3.1 percentage points, than Bank Rate (Figure 7). Even in terms of rate changes,
the relationship between the two policy rates did not appear close (Figure 8). The coefficientof correlation was -0.140 in level and -0.295 in annual percentage change. Yet, a formal test(see Table 2) suggests that the Bank of Japan’s discount rate responded to the one-month
lagged Bank of England Bank Rate (at the 5 percent level of significance), though a similar
response cannot be identified in quarterly data, irrespective of whether the current or lagged
value of Bank Rate is used. The sum of gold and capital flows is identically equal (in absolutevalue) to trade flows. What appears to be a systematic response to Bank Rate may well be an
artifact of the systematic response to trade flows.

23

Figure 7. The Bank of Japan Discount Rate and the Bank ofEngland Bank Rate, October 1897–July 1914
10
8
6
4
2
Oct-1897
May-1898
Dec-1898
Jul-1899
Feb-1900
Sep-1900
Apr-1901
Nov-1901
Jun-1902
Jan-1903
Aug-1903
Mar-1904
Oct-1904
May-1905
Dec-1905
Jul-1906
Feb-1907
Sep-1907
Apr-1908
Nov-1908
Jun-1909
Jan-1910
Aug-1910
Mar-1911
Oct-1911
May-1912
Dec-1912
Jul-1913
Feb-19140Bank of Japan discount rate

Bank of England Bank Rate

Source: Bank of Japan (1986), pp. 356, 374 and Federal Reserve Bani of St. Louis (https://fred.stlouisfed.org).

Figure 8. The Bank of Japan Discount Rate and the Bank ofEngland Bank Rate, October 1898–July 1914
(In annual percentage-point changes)
4
2
0
-2
-4
Oct-1898
Apr-1899
Oct-1899
Apr-1900
Oct-1900
Apr-1901
Oct-1901
Apr-1902
Oct-1902
Apr-1903
Oct-1903
Apr-1904
Oct-1904
Apr-1905
Oct-1905
Apr-1906
Oct-1906
Apr-1907
Oct-1907
Apr-1908
Oct-1908
Apr-1909
Oct-1909
Apr-1910
Oct-1910
Apr-1911
Oct-1911
Apr-1912
Oct-1912
Apr-1913
Oct-1913
Apr-1914-6Bank of Japan discount rate

Bank of England Bank Rate

Source: author’s calculation based on Bank of Japan (1986), pp. 356, 374 and Federal Reserve Bani of St. Louis(https://fred.stlouisfed.org).

We can only offer a conjecture as to why the relationship between discount ratechanges and monetary gold movements weakened. In 1911, the Japanese government had asense of crisis about the sustainability of the gold standard, given the large and persistent
trade deficit. On August 10, a formal agreement was reached between the ministry of financeand the Bank of Japan (Bank of Japan 1983; Kojima 1981), stipulating that the discount rateshould be changed in response to monetary gold movements caused by “natural” economic
forces. It gave an indicative “normal point (heijunten)” of ¥200 million, suggesting that thecentral bank should raise the discount rate when the balance of monetary gold fell below thislevel. At the same time, it also gave an indicative “minimum limit (saitei gendo) of ¥180

24
million, suggesting that the government would replenish monetary gold by “unnatural” means(i.e., government borrowing) when the balance fell below this level.
The relationship between discount rate changes and monetary gold movements
weakened because the Bank of Japan, in an attempt to observe this agreement, kept thediscount rate high. It raised the rate steadily over the coming years, from 4.75 percent initiallyto 5.48 percent in September 1911 and in several steps to 7.3 percent in July 1914. No longer
were the discount rate changes during this period divergent from the Bank of England’s Bank
Rate changes (see Figure 8). The weakened relationship also mirrored the similarly weakened
relationship between the discount rate and the extra issue tax. It was no less indicative of thecentral bank’s commitment to preserving gold convertibility.
8. Conclusion
This paper has explored Japanese monetary policy under the classical gold standard(1897–1914), while providing a succinct exposition of the distinguishing features of Japan’s
gold standard regime. From around 1904, the monetary authorities, instead of maintaining thegold parity through the free private movements of gold, did so largely by selling and buying
foreign exchange held abroad at a fixed rate. For this purpose, they maintained financial
assets denominated in gold-convertible currencies. These overseas “specie” balances were
kept in major foreign financial centers, especially in London, and part of the funds werecounted as part of the Bank of Japan’s monetary gold reserve.
The Bank of Japan initially used fiduciary issues to offset movements in monetary
gold so as to stabilize the supply of currency but, from around 1909, almost entirely usedfiduciary issues to accommodate changes in the public’s demand for currency. The incentive
mechanism of the extra issue tax functioned as intended, that is, the Bank of Japan moved thediscount rate in the same direction as the government moved the tax rate. Finally, the Bank ofJapan raised the discount rate when there was a gold outflow. This rules-of-the-game-like25
behavior of the Bank of Japan, which was motivated by its mandate to preserve gold
convertibility, was consistent and robust, challenging the semi-consensual view that
violations of the rules of the game were frequent and pervasive under the gold standard.
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