Discussion Paper Series No.191

A Myth of “the Keynesian before Keynes:”
Low Interest Rate Policy in the Early 1930s in JapanSHIZUME Masato

June

Kobe University

2006

Discussion papers are a series of manuscripts in their draft form.
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A Myth of “the Keynesian before Keynes:”
Low Interest Rate Policy in the Early 1930s in Japan

Masato Shizume*
Research Institute for Economics and Business Administration
Kobe University
Rokkodai 2-1, Nada-ku, Kobe 657-8501, Japan
E-mail:shizume@rieb.kobe-u.ac.jp
June 2006[Abstract]
Departing from the gold standard was the necessary condition for early recovery fromthe Great Depression in 1930s (Eichengreen and Sachs[1985]). Then, was it thesufficient condition for an independent monetary policy? I explore Japan’s monetary
policy during the interwar period, focusing on the macroeconomic policy innovation in
the early 1930s. I explore the view of the Japanese policymakers at that time, making
use of newly available archives from the Bank of Japan. I derive a new series ofrepresentative long-term interest rate data from the market price of one particulargovernment bond. Then, I explore the relationship between long-term interest rates ofJapan and the two financial centers, Great Britain and the United States. The
Japanese experience shows how strong the Golden Fetters were during thepost-gold-standard era. The institution of the gold standard had an enduring influence
on Japanese policymakers, even after its constraints were no longer formally binding.

JEL Classification: E42, N15* I thank Mariko Hatase, Hideki Izawa, John James, Yoichi Matsubayashi, Ryuzo

Miyao, Takashi Nanjo, Kunio Okina, Mari Onuki, Hugh Rockoff and Richard Smethurst
for helpful comments and discussions. Any remaining errors are of my own.
1

1. Introduction
The international gold standard was regarded as the most sophisticatedmonetary institution before the First World War (WWI). London was the world financial
center. Policymakers around the world followed “the rules of the game” of the gold
standard to keep the gold parity. And the efforts by the policymakers strengthened theinternational monetary system as a whole.
The situation changed after WWI. Money did not flow from creditor countries
to debtor countries as before. After the suspension of the gold standard during WWI, thepolicymakers tried to restore the gold standard. Their efforts did not succeed and ended
up with the Great Depression. In retrospect, the policymakers were obsessed by theGolden Fetters (Eichengreen [1995]).
Departing from the gold standard was the necessary condition for earlyrecovery from the Great Depression in 1930s (Eichengreen and Sachs[1985]). Then, wasit the sufficient condition for independent monetary policy? In this study, the case forJapan shows that the answer was NO. The Japanese experience shows how strong theGolden Fetters were during the post-gold-standard era. The institution of the gold
standard had an enduring influence on Japanese policymakers, even after its
constraints were no longer formally binding.1
Japan’s economic policy during the interwar period was strongly influenced byboth the gold standard and the Great Depression. Japan joined the gold standard in
October 1897. Japan suspended the gold standard in September 1917, following theWestern countries. Japan tried to return to the gold standard in the 1920s, and finallyThis study is complement to Eichengreen [1995] in a sense. He views the gold
standard system as a kind of decentralized cooperation mechanism with inherent
vulnerability. He describes the Great Depression as a case for the vulnerability camereal. His study focuses mainly on the core countries though he mentioned someperipheral countries including Japan. This study is an attempt to explore how aperipheral country looked at and responded to the collapse of the system.

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did so in January 1930. Japan departed from the gold standard in December 1931 under
the leadership of Korekiyo Takahashi, who returned to the Finance Minister position, inthe midst of the Great Depression.
Many observers argue that Takahashi brought new policy institutions. They
are impressed by economic policies conducted by Takahashi and his colleagues in theearly 1930s. Some claim that Takahashi intuitively understood the mechanism of theKeynesian policy before Keynes’ seminal work of General Theory of Employment,Interest and Money in 1936, and virtually carried out Keynesian policies without any
contact with Keynes and his colleagues.2 Some argue that Takahashi’s three-pronged
economic stimulus package, depreciation of the yen, expansion of government spending,and lowering of interest rates, contributed to the early recovery of the Japanese
economy from the Great Depression (Nakamura [1971], Patrick [1971]). Some argue
that Takahashi’s era was the turning point of policy regime from laissez-faire to active
interventions and strict control of the national economy by the government in Japan(Miwa [1982], Ito [1989]).
There are only a few previous studies employing quantitative analyses on
Takahashi’s economic policies. Nanto and Takagi [1985] stress the effects of theincrease in exports accompanying the depreciation of the yen. Cha [2003] emphasizes
the effects of the debt-financed fiscal expansion. Yet, very few have focused on thedevelopments of monetary policy during Takahashi’s era. Most previous studies havebeen constrained by the lack of data and historical materials when conducting empiricalresearch on monetary policy in the interwar Japan.
I explore Japan’s monetary policy during the interwar period by focusing on themacroeconomic policy innovation in the early 1930s. I explore the contemporary view ofKindleberger [1973], pp.166-167. I define the Keynesian policy as a discretionary
macroeconomic policy either on the monetary or fiscal side associated with a managed
currency system.

2

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the Japanese policymakers at that time, making use of newly available archives fromthe Bank of Japan (BOJ). I derive a new series of representative long-term interest rate
data from the market price of one kind of government bond to overcome the data
constraints. And I explore the relationship between long-term interest rates of Japanand the two financial centers, Britain and the United States.

2. Macroeconomic Policy Trilemma
Obstfeld and Taylor [1997, 2004] utilize the concept of the macroeconomic
policy trilemma in historical studies of a number of countries’ monetary policies. They
claim that a chosen macroeconomic policy regime can only succeed in at most two out of
three goals:
1) full freedom of cross-border capital movements,
2) a fixed exchange rate,3) independent monetary policy oriented toward domestic objectives.
They argue that the gold standard is the typical case of maintaining freecapital movements and a fixed exchange rate, while sacrificing independent monetary
policy. They also argue that national policymakers became more inclined to controllinginternational capital flows after the financial upheavals of the Great Depression.3
Kindleberger describe the essence of Takahashi’s economic policies as deficit
financing with the flexible exchange rates.4 Kindleberger’s notion presumes that if theJapanese policymakers decided to pursue an independent monetary policy whichenabled deficit financing, they should also move to the flexible exchange rate system.5
Interwar Japan was a typical small and open economy, and its economic
Komiya and Suda [1983] look at the postwar Japan’s choices of monetary policy
regime and exchange rate system in the same context.
4 Kindleberger [1973], p.166.
5 In the same context, Hamilton [1988] claims that the government’s commitment tofiscal soundness and monetary stability was the essential part of the gold standard.
34policies were subject to international conditions. The question is; were the Japanesepolicymakers, including Takahashi, free from the influence of the fixed exchange rate
system? A flexible exchange rate system might not have been applicable topost-gold-standard Japan as it was a small and open economy. If so, how did Takahashi
and his colleagues bring a quick and robust recovery in the midst of the Great
Depression? I will try to answer these questions in the remainder of this paper by
employing narrative and quantitative analyses.

3. Some Basic Facts
I will now review some related events, focusing on the return to and departurefrom the gold standard. Then, I will look at macroeconomic indicators.
Japan lifted the gold embargo and effectively resumed convertibility of the yen
on January 11, 1930. Japan was the last of the gold club member countries to return togold standard after World War I. Japan imposed the gold embargo again and effectively
departed from the gold standard on December 13, 1931. The day of Japanese departure
was about 3 months after the British departure, and the first day that Takahashi
became Finance Minister again. Takahashi served as Finance Minister, except for a few
months, until February 26, 1936, when he was assassinated by a group of militarists.6
Japan stayed the gold standard for less than 2 years. The period of de jure gold
standard for interwar Japan was shorter than any other gold club members.7 That does
not mean, however, that Japan was free from the enduring influence of the gold
standard in the pre- and post-gold standard period.
Figure 1 shows the developments in the yen rate to the pound-sterling and to
He once resigned on the cabinet resignation in July 1934, and came back in office inNovember of the year.
7 The second shortest next to Japan is Switzerland, which stayed on gold for 3 years
and 2 months (August 1928-September 1931), and the third is Norway, which stayed ongold for 3 years and 5 months (May 1928-September 1931). Bank of Japan [1997].
6

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the dollar. It confirms the commitment to the par rate during de jure gold standard. It
also suggests efforts by Japanese government to stabilize the yen at around thepre-WWI par rate during the pre-gold standard period. It highlights the sharp decline
right after the departure from the gold standard. The yen depreciated by 40 percent vis
à vis the pound-sterling from the old parity rate when the rate was stabilized again at
the new level in the beginning of 1933.
I should note that for Japan, departing from the gold standard did notnecessarily mean moving to a flexible exchange rate system. Rather, it meant a one-shot
devaluation under a fixed exchange rate system. As a small open economy, Japan had
good economic reasons to peg: to settle its trade account and to give relief tointernational investors.8 Also, Japan had a good political reason to return to and stayon the gold standard. One of the criteria for participating in the establishment of Bankfor International Settlements (BIS) in 1929 was to have a “stable currency.”9
Figure 2 shows the developments in prices of goods and stocks from January
1928 through December 1936. Commodity prices declined in 1930 and 1931. Comparedto the end of 1928, the wholesale price index fell by 39 percent, and the retail price index
fell by 31 percent by October 1931. Prices of goods rebounded in the first half ofTakahashi’s term and were stable for the remainder of his term.
Stock prices dropped before the return to gold and stagnated during the gold
standard period. They rebounded during Takahashi’s term. The Oriental Economist

Previously issued Japanese external bonds matured in January 1931. The bonds were
issued in 1905 during the Russo-Japanese War and denominated in the pound-sterling.
Before the Japanese returning to gold, the Western investors insisted that the stablecurrency of Japan was prerequisite for the debt conversion. Japan successfully issued
refinancing bonds in May 1930, after returning to gold.
9 In the negotiation in the Young Committee, “the stable currency” referred to keeping
gold parity. Japan succeeded to include an exceptional clause for a victorious county to
be able to participate without referring to the stable currency clause. Still, Japanesenegotiators regarded joining to and staying on the gold standard as a source of power
within BIS. Cho [2001], p.100.
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Stock Price Index peaked in July 1928, fell by 64 percent by October 1930, andstagnated afterwards until the end of 1931. It surged during the first half ofTakahashi’s term, and regained its 1928 peak level by the beginning of 1934.
Figure 3 shows the developments in interest rates. The Bank of Japan (BOJ)
kept its official discount rate (ODR) at 5.48 percent through 1928-29, and reduced therate to 5.11 percent in October 1930. After the British departure from gold in September
1931, BOJ raised the rate twice to 6.57 percent through the end of the year to suppress
capital outflow.
After departing from the gold standard, BOJ reduced the rate three times in1932 and once in 1933. The rate fell to an unprecedented low of 3.65 percent from July
1933 through the end of Takahashi’s term.10
I should note that interest rates in private sector were higher than the ODR
and more or less uncorrelated with the ODR. That may have reflected high credit risk
premium on private debts under the financial instability in interwar Japan. I will
return to this point later in this paper.
Figure 4 shows the developments in monetary aggregates. “Cash incirculation” (the definition close to M1) peaked in August 1929 and dropped by 26
percent by June 1931. It rebounded during Takahashi’s term.11 Increase in money
during Takahashi’s term was consistent with fall in interest rates, reflecting easy
monetary policy.
In general, macroeconomic indicators show signs of contraction during theperiod on gold and signs of recovery during Takahashi’s term.
BOJ further lowered the rate to 3.29 percent in April 1936 after the assassination of
Takahashi.
11 From September 1931, BOJ began to report monthly data of “bank deposits” and“bank lending” at the biannual Meetings of Directors and Branch Managers. “Bankdeposits” shows similar developments with “cash in circulation.” It is presumable thatreporting of “bank deposits” itself reflects BOJ’s attempts for maintaining price stability
without the anchor of gold.
107

4. Narrative Analyses
I will now explore the views of the Japanese policymakers at that time,
especially at BOJ. I make use of newly available materials from the BOJ Archive,
including the minutes of the biannual Meetings of Directors and Branch Managers.12
The narrative analyses illustrate the enduring influence of the gold standard
on policy. The analyses suggest that Japanese policymakers were not free from theGolden Fetters before returning to, and even after departing from, the gold standard.
The policymakers sacrificed monetary policy autonomy in order to stabilize theexchange rate and to maintain free capital movements under de jure gold standard. The
policymakers also did the same thing during the suspension period of the gold standard
in 1920s. The policymakers had a “fear of floating” after departing from the gold
standard in December 1931.

(1) The Period of the Suspended Gold Standard (1919-1929)
BOJ Archive materials show that Japanese policymakers intended to return to
the gold standard eventually, but for various reasons held back from doing so in a hurry.
Incidents such as the Great Kanto Earthquake in September 1923 and the Financial
Panic in spring of 1927, hinder the government’s final decision.
When Britain returned to gold standard in April 1925, Osachi Hamaguchi ofKensei-Kai Party was Finance Minister.13 He claimed that, in commenting on the
British action, “We wish to follow them immediately, since that is on the right track of

BOJ Archives became open to the public in 2002, but some of the documents were
published by BOJ before that.
13 Both of Kensei-Kai (later Minsei-To) and Seiyu-Kai parties supported returning to
the gold standard. Kensei-Kai was more active in promoting the preparation measures
such as tight money and balanced budget, but the difference was only a matter ofnuance. Cho [2001], p.101.
128

the gold standard. Unfortunately, we cannot do so right now because our conditions
today do not allow it.”14
In January 1928, Finance Minister Chuzo Mitsuchi of Seiyu-Kai Cabinet
announced that conditions were improving. He said, “We see good progress in businessand financial restructuring since the Financial Panic of last spring. . . The balance of
payments is improving. Exchange rates are steady reflecting favorable fundamentals
without any artificial measures.”15
On July 2, 1929, Seiyu-Kai Cabinet resigned and Hamaguchi of Minsei-to
Party (ex-Kensei-Kai) came to power. The Hamaguchi cabinet was committed to early
lifting of the gold embargo. Former BOJ Governor Junnosuke Inoue joined the cabinet
as Finance Minister.
On August 28, Prime Minister Hamaguchi distributed a leaflet to all families
in Japan, and made a radio speech about the gold standard. In the leaflet, he said, “I
believe that our country should lift the gold embargo immediately and get back on theright track of the international economy. . . To prepare for this, we must tighten our
public and private economies as much as possible to decrease prices and imports. . . We
should shrink today to grow tomorrow.”16
On November 21, Hamaguchi announced, “With all the internal and external
preparation completed, I am now convinced that there are no economic obstacles tolifting the gold embargo. I order the Ministry of Finance (MOF) to lift the gold embargo,effective on January 11, 1930.”17“Statement by Finance Minister Osachi Hamaguchi,” Miyako Shinbun, April 30,
1925, reprinted in Bank of Japan [1968], pp.390-391.
15 “Address by Finance Minister Chuzo Mitsuchi,” Parliamentary Paper, House ofRepresentatives, January 21, 1928, reprinted in Bank of Japan [1968], pp.83-84.
16 “Zen-Kokumin-ni Uttau” (Call upon All the People), August 28, 1929, reprinted in
Bank of Japan [1968], pp.395-396.
17 “Kin-Kaikin-ni Saisite” (On Lifting of the Gold Embargo), November 21, 1929,
reprinted in Bank of Japan [1968], pp.396-397.
149

(2) The Period on Gold (1930-1931)
On January 11, 1930, Japan returned to the gold standard, and stayed on goldfor 1 year and 11 months. The BOJ Archive materials show that Japanese policymakers
clearly sacrificed monetary policy autonomy to maintain gold parity and capital
mobility.
BOJ Governor Hisaakira Hijikata spoke at the Spring Meeting of BOJ
Directors and Branch Managers on May 11, 1931. At that time, his main concern was
how to keep external balance and exchange rate parity, and he felt no responsibility forthe domestic economy. He said, “I cannot commit to improving business conditions inJapan’s current domestic climate. I can say nothing more than to expect gradualimprovement with more efforts by business community. I expect little effects of policy
measures for now. . . Exchange rates are generally stable around the par level even in
the season of the year in which volume of imports tend to mount. . . I don’t expect large
specie outflows in the future. . . I expect the balance of payments of fiscal 1931 to bebalanced or at a small deficit.”18
Britain abandoned the convertibility of pound-sterling on September 21, 1931,
and Japan stayed on gold for 3 months more. BOJ tried to suppress capital outflows to
support the gold standard. Market participants anticipated that Japan would follow
Britain, inducing massive capital outflows. BOJ raised the ODR twice on October 6 andon November 5. This was the classical gold standard adjustment for a central bankfacing capital outflow (Bagehot [1873]).
The Research Department of BOJ submitted a report dated October 13, 1931 to
the Fall Meeting of Directors and Branch Managers. It stated, “The British departure“Documents on the biannual Meetings of Directors and Branch Managers,
Spring-Fall, 1931,” BOJ Archive No.3942.

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from the gold standard triggered other countries to be suspect each other… Rumors
floated in London and the European Continent. The rumors suggested that Japan also
might impose a gold embargo. . .We have been forced to ship substantial amount ofspecie abroad. . . BOJ, responsible for maintaining the gold standard and formaintaining specie, has followed the normal principles under such internal andexternal circumstances, and raised the rate.”19
Eigo Fukai, a distinguished economist and then Vice Governor of BOJ, later
wrote in his memoirs, “In retrospect, it would have been sensible for Japan to departfrom the gold standard immediately because the British departure was a change inglobal situation. . . But Japan held still enough specie, even though it had lost someafter the lifting of gold embargo. The trade balance had improved, and the balance of
payments was in equilibrium. Considering this, we concluded that it was possible tostay on gold as a matter of pure monetary policy.”20
Fukai’s memoirs suggest the contagious aspect of the British financial crisis.
Japan was in a vulnerable position in the international finance. If things went normally,
there might be no problem. But, the British financial crisis triggered the capital flightfrom Japan within the chain-reaction toward the collapse of the international gold
standard.

(3) The Period after the Gold Standard (1932-1938)
Fukai wrote in his memoirs that he gave four pieces of advice to the returning
Finance Minister Takahashi on December 13, 1931, the day of Takahashi’s
appointment.21“Documents on the biannual Meetings of Directors and Branch Managers,
Spring-Fall, 1931,” BOJ Archive No.3942.
20 Fukai [1941], pp.251-252.
21 According to Fukai’s memoirs, the resigning Finance Minister Inoue consulted Fukai
about the transition of foreign exchange arrangements on December 11. Then, Fukai
19111) impose a gold embargo immediately,2) abandon gold convertibility of the yen with an emergency imperial decree as soon
as possible,3) conduct a prudent monetary policy to control the money supply in absence of thegold standard’s controls in order to maintain the value of currency,
4) take the required legal actions to control foreign exchange transactions if thesewere necessary.
Fukai got a mixed response from Takahashi. Takahashi resisted the second
point of abandoning the gold convertibility, while totally agreeing with the first andthird points

of immediate gold embargo and prudent monetary policy. Fukai wassurprised by Takahashi’s resistance on the second point. Fukai surmised, “Mr.
Takahashi seemed to want to avoid cutting a formal linkage between gold and thecurrency.” Takahashi was indifferent about the forth point of foreign exchange control.22
The Capital Flight Prevention Law was proclaimed on July 1, 1932, and cameinto effect on the same day. Under the law, the government reserved the power toimpose restrictions on foreign exchange transactions.
A MOF official explained that international capital movements were still free
in principle and that capital controls were regarded as exceptional under the Capital
Flight Prevention Law. Kazuo Aoki, the Chief of Treasury Division, Financial Bureau of
MOF, said in an explanatory session in the Diet, “We will secure the freedom ofinternational capital flow in principle.”23

discussed on the issue with MOF, Yokohama Specie Bank and other BOJ officials.
Fukai met Takahashi at around 3 pm. on December 13, and Takahashi assumed theoffice of Finance Minister in the evening of the day. Fukai act as one of primary policy
adviser to Takahashi throughout Takahashi’s term. Those episodes indicate Fukai’s
close ties with two Finance Ministers and his key role in the policy transition. Fukai[1941], pp.255-259.
22 Fukai [1941], pp.260-263.
23 Osaka Bankers Association [1932], pp.107-108.
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BOJ Archive materials show that contemporary policymakers at that time
were aware of the macroeconomic policy trilemma. Tetsuzo Horikoshi, an executive
director of BOJ, spoke about the Capital Flight Prevention Law at the Fall Meeting of
Directors and Branch Managers in 1932.24 He said that the purpose of the Law was togive the government the power to regulate foreign exchange transactions. He said, “Ifmoney increases by domestic policies, the exchange rate may fall. If we intend tomaintain the exchange rate, we should curb our domestic policy. If we dare to pursue
the domestic policy, we should sacrifice the exchange rate. We face risk with the gold
embargo only. We should bring the equilibrium of balance of payments to stabilize theexchange rate. We may need some measure for balancing the balance of payments.”
Horikoshi expressed “fear of floating” in the speech, mentioning BOJ’s concern
for capital flight. He said, “The primary concern for this country (at the time of lifting
the gold embargo) was if the domestic investors would rush to foreign securities,
inducing massive capital outflows, in the event of declining values of Japanese overseas
bonds. BOJ advised the government to prepare for regulating these capital outflows.”
Horikoshi suggested little contradiction between Japanese domestic policy
objectives and international capital flows in the current condition, and he indicated nourgent need for tight regulations to avoid capital outflows. He said, “So far, we havebeen managing with this formula. I don’t know if this kind of formula will be enough if
things change in future. We might have to impose tighter regulations such as foreignexchange controls.”
The Foreign Exchange Control Law was proclaimed on March 29, 1933 andcame into effect on May 1 of the year. Under the law, the regulations on foreignexchange transactions were substantially extended and tightened. Almost all the“Documents on the biannual Meetings of Directors and Branch Managers,
Spring-Fall, 1932,” BOJ Archive No.3943.

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transactions related to international capital flows were subject to regulation. At thesame time, speculations on foreign exchange were forbidden by finance ministryordinance.
Some narrative materials suggest that those laws and related actions by theauthorities reduced international capital mobility. Takahashi spoke at the Bills
Exchange Association Meeting on April 21, 1933. He said, “The government hasestablished the measures to prevent domestic capital from flowing out of control. Now,
we are able to pursue low interest rate policy to the full extent.”25 Fukai later noted,“The measures actually adopted for exchange control were of a mild in nature; but adeclaration by the Government in November, 1932, that it was determined to enforce
drastic measures in case of need proved decisive.”26
We cannot be sure from narrative evidence how strong the need for the foreignexchange control was, and how effective the control was. In this regard, quantitative
analyses are supplementary to the narrative analyses.

5. Constructing A Series of Long-Term Interest Rate Data
(1) Previously Available Interest Rate Data
Obstfeld, Shambaugh, and Taylor [2004] use interest rates on bills discounted
by banks and bills issued by the government (typically, treasury bills) to explore therelationship of countries’ short term rates, including Japanese ones. In their analysis,
Japan appears to be an outlier. Their analysis indicates that interest rates in peripheral
countries moved together with those in the center country during the interwar period,
implying that peripheral countries’ monetary policies were more or less dependent on
the center country. Their analysis suggests that Japanese interest rates had a weaker“Speech by Finance Minister Takahashi at the Bills Exchange Association Meeting,”
Osaka Bankers Association [1933], No. 429, pp.17-25.
26 Fukai [1937], p.392.
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relationship with those of center country than did those of other peripheral countries.
The reported results of weak relationship of Japanese interest rates with thoseof the center country may be due to inadequate data. Previously available short-term
interest rate data for the interwar period in Japan were those for private sector debts
such as bills discounted at banks or certificates of lending of banks.27 Those interest
rates were subject to a high credit risk premium. The Japanese economy suffered fromperiodical financial panics and financial instability in the interwar period, and private
debts were subject to high credit risk.
Figure 5 reports short-term interest rates in private sectors in Japan, Britain
and the United States. Apparently, Japanese rates moved differently from the others,
while British and American rates moved along with each other. Especially, Japanese
rates were higher than the other two rates in the middle of 1920s and 1930s.
Table 1 shows the results of unit root tests for short-term interest rates on
private sector debts in the three countries. I employ Augmented Dickey-Fuller (ADF)
tests and Phillips-Perron (PP) tests. The results suggest the difference in time-series
properties between the short-term interest rates in Japan and in the other two
countries. The tests reject the existence of a unit root for Japan, indicating stationality,
while failing to reject the existence of a unit root for Britain and the United States,
indicating non-stationarity.28 There are no representative short-term interest rates on
public debt in the interwar Japan such as treasury-bill rates to substitute for the
existing data.29
27 The interest rates for “bills discounted” and “certificates of lending” were reported by
Tokyo Bankers Association. Their maturities varied, and they were often refinanced on
maturity. According to Aoki [1932], the average maturities in 1927 were about 2 months
for bills discounted and 8 months for certificates of lending (Aoki [1932], p.45). It is
often claimed that certificates of lending included various kinds of lending with higher
risk and less liquidity than bills discounted. Sano [1936], p.8.
28 To be precise, I get some mixed results. PP test for Britain fails to reject the existenceof a unit root, while ADF test reject it at 5 percent level of significance.
29 Treasury bills were issued occasionally during the interwar period. But, they were

15

There are, however, long-term interest data for government bonds. Nippon
Kangyo Ginko (Japan Hypothec Bank) collected the price data for bonds, and calculated
compound yields to maturity of the bonds. The series begins only from July 1921, andthe data is calculated only for the first working day of each month. Appropriate interest
rate data for Japan are needed to explore the international relationship of interest
rates.

(2) A New Series of Long-term Interest Rates
I have created a new series of long-term interest rate data. I derived it from themarket prices of a government bond called “Ko-go” 5 percent government bond.30 I use
the price data of the “Ko-go” at spot transactions of the Tokyo Stock Exchange (TSE). I
calculate compound yields to maturity on monthly average prices from January 1919 to
December 1938.31 32
During the interwar period, investors traded various types of bonds, including
government bonds, municipal bonds and corporate bonds, both in the official markets
and over the counter of securities companies. TSE served as the central market ofJapan. In November 1932, TSE listed 37 issues of Japanese government bonds, 1 issue
of foreign (Chinese) government bond, 95 issues of municipal bonds and 463 issues ofcorporate bonds at its spot transactions.
For two reasons, the interest rates on government bonds are important for thecirculated for short time and the availability of the interest rate data was limited.
“Ko-go” 5 percent bond was issued in 1908-09 after 17 big private railway companies
were nationalized in 1906-07. It was delivered to stockholders of previous railway
companies. The maturity date was in 1962-63.
31 I use the “yield” function of excel spreadsheets. The monthly average price means thesum of traded values of bonds divided by the sum of traded quantities of bonds in amonth.
32 I compare the results of my calculation with that of the previously available Nippon
Kangyo Ginko data. Nippon Kangyo Ginko did not publish the process of calculation. So,
I calculate the yield at the same day and for the same bond as theirs, and thediscrepancies are less than 1 basis point (a hundredth of 1 percent).
30

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analyses on monetary policy during the interwar period in Japan. First, the interest
rates on government bonds are credit-risk-free interest rates which are comparable toother countries’ interest rates. The rates on government bonds do not contain credit risk
premium. In this regard, Interest rates on government bonds are different from otheravailable interest rate series such as bills discounted or certificates of lending. Second,
they were policy target rates for Japanese policymakers in the 1930s. 33 Fukai later
observed Japanese monetary policy in the early 1930s as “Lowering interest rates on
government bonds was essential to lower interest rates in general.” 34 The BOJ in the
1930s regarded the open market operation of government bonds as one of its primarypolicy measures.
I have used “Ko-go” 5 percent government bond for deriving the representative
long-term interest rate during the interwar period in Japan because investors regarded
the “Ko-go” as the benchmark issue. The “Ko-go” was the most-actively-traded bondduring the interwar Japan. Trading in the “Ko-go” accounted for 18 percent of the total
number of transactions in government bonds at TSE in 1932.

6. Econometric Analyses
Using government bond data, I will now explore the relationship between
long-term interest rates of Japan and two international financial centers, Great Britain
and the Unites States.35 I extend the approach taken by Obstfeld and Taylor [2004] andTheoretically, long-term interest rates are sum of the average of short-term interest
rates in future, and the term premium. It is another issue to be explored how effectively
a central bank is able to control long-term interest rates even if it enjoys theindependent monetary policy from abroad. I just add that today’s central bankers havebig concern over developments in long-term interest rates, too.
34 Fukai [1941], p.365.
35 Long-term interest rate data for Britain and United States, which I use in this study,
are monthly averages. The data for Britain are obtained from the NBER Macrohistory
Database (http://www.nber.org/databases/macrohistory/contents/). The original data for
Britain are from Board of Trade, Statistical Abstract for the United Kingdom. The data
for United States are from Board of Governors of the Federal Reserve System, Banking
33

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Obstfeld, Shambaugh, and Taylor [2004], using the degree of co-movements of domestic
and international interest rates as the indicator of sacrificing independent monetary
policy.

(1) Time-series Properties of the Long-term Interest Rates
I examine the basic time-series properties of long-term interest rates in three
countries. Figure 6 shows developments in the long-term interest rates from January
1919 to December 1938.
Table 2 reports the results of unit root tests for the long-term interest rates inthe three countries. The results indicate that the order of integration of the long-term
interest rates of the three countries is all one.36
I employ Granger causality tests on the interest rates in the three countries
with the formula (1).
p

p

p

i =1

i =1

i =1

∆Rt = a 0 + ∑ ai ∆Rt −i + ∑ a F 1,i ∆R F 1,t −i + ∑ a F 2,i ∆R F 2,t −i + u t ,(1)

Rt denotes the domestic interest rate at time t, and RFj ,t denotes the foreign country’s
interest rate at time t (j=1,2).
Table 3 reports the results of Granger causality tests. The results are
consistent with the conventional arguments on the interwar Japan as a small and open
economy. The results indicate that movements in lagged foreign interest rates are
statistically significant in explaining movements in current Japanese interest rates.
Japanese long-term interest rates are Granger-caused by both of British and American
rates with a lag of one month. Neither of British nor American long-term interest rates
is Granger-caused by Japanese rates with a lag of one month. That is consistent withand Monetary Statistics, 1943, p.429 and pp.468-471.

36 To be precise, ADF test fails to reject the existence of a unit root for Japan, while PP
test rejects it at 10 percent level of significance.

18

the notion that Japan was a peripheral country.
All of three countries’ interest rates are Granger-caused by each other withlags of more than two month. That is consistent with the conventional understandingthat the international financial market was integrated.

(2) Preparatory Tests for examining the Long-run RelationshipI examine the long-run relationship, defined as cointegration, in the interest
rates of Japan and the two international financial centers. Table 4 reports the results ofcointegration tests presented by Engle and Granger [1987]. It indicates that theJapanese long-term interest rates were cointegrated with the British ones through theinterwar period. This result implies that the Japanese rates hold a stable long-run level
relationship with the British ones. It indicates no such relationship between theJapanese rates and the American ones. This result implies that the Japanese rates holdno such a stable long-run level relationship with the American ones.
Gregory and Hansen [1996] argue that a simple cointegration test fails to
detect cointegration in case of a structural change in the long-run level relationshipbetween variables. I conduct cointegration tests with a structural change presented by
Gregory and Hansen [1996], for the relationship between Japanese and American
long-term interest rates. Table 5 reports the results. It indicates that the Japanese
long-term interest rates were cointegrated with the American ones during the interwar
period, and that there was a structural change in the relationship from around the endof 1932 or the beginning of 1933.
Table 4 also reports the result of the cointegration test between Japanese andBritish short-term interest rates on bills discounted at private banks. It indicates nocointegrating relationship between the Japanese short-term interest rates and the19

British ones.37(3) Error Correction Models
An error correction model is applicable when there is a cointegrating
relationship among a set of variables. The model describes the behavior of the variables
to converge to the cointegrating relationship, a long-run equilibrium. In the model, thecointegration term is called the error correction term.
I formulate error correction models which explain the difference of Japanese
long-term interest rates by lag-difference terms38 and an error correction term.39 The
formula is expressed by equation (2).

∆Rt = α + ∑ β j ∆Rt − j + ∑ γ j ∆Rb ,t − j + ω (σ + Rt −1 − θRb ,t −1 ) + u t ,
p

p

j =1

j =0

(2)

Rt denotes the domestic interest rate at time t, and Rb ,t denotes the internationalbase rate at time t. Table 6 reports the regression results.
Obstfeld and Taylor [2004] and Obstfeld, Shambaugh, and Taylor [2004] argue
that the cointegrating slope coefficient, θ , represents the long-term level relationshipbetween the domestic interest rate and the international base rate. The expected sign ofθ is positive. If the domestic interest rate moves parallel with the international baserate, then, θ = 1 . They also argue that the absolute value of the coefficient of error
correction term, or the adjustment speed, ω , represents the degree of dependency ofthe domestic interest rate towards the international base rate.40
It is arguable to test the cointegration between these two series, since the unit root
tests indicate that Japanese short-term interest rate series is stationary, or I(0), andthat British short-term interest rate series is non-stationary, or I(1). I report the resultsof the cointegration tests for the comparison between short- and long-term interest
rates.
38 Lag orders are chosen by Schwarz information criteria.
39 Cointergrating vectors are calculated by the dynamic OLS method proposed by Stockand Watson [1993]. Lag orders are chosen by Schwarz information criteria.
40 They employ the method developed by Pesaran, Shin, and Smith [2001] (PSS test) for
testing the significance of the level relationship among a large set of country data. Since
37

20

First, I use British interest rate as the international base rate. I conduct two
patterns of regressions regarding lag structure. In the formula reported in the firstcolumn, a), I use the same lag pattern as Obstfeld and Taylor [2004] and Obstfeld,
Shambaugh, and Taylor [2004]. Their formula includes the difference of the base rate intime t ( ∆Rb ,t ) in explanatory variables.41 In the formula reported in the second column,b), I use the lag pattern used in a standard error correction formula, which does notinclude the difference of the base rate in time t ( ∆Rb ,t ) in explanatory variables.
Different lag patterns give qualitatively the same results. The coefficient γ 1 is
not statistically significant. Other coefficients are statistically significant and have theexpected signs. The statistical significance of γ 0 indicates the immediate impact on
Japanese interest rates of British rates. The cointegrating slope coefficient, θ , isstatistically significant, confirming the long-term level relationship between Japaneseand British interest rates. The coefficient of error correction term or the adjustment
speed, ω , has the absolute value of .07, indicating that the half-life of the initial
disturbing shock to the long-run relationship is 9 to 10 months.
Second, I use American interest rate as the international base rate. I conduct
the same regression as British rate, of which result is reported in the third column, c). I
should note that the result in column c) has to be taken with a reservation because thecointegration tests support the existence of structural change in the long-run
relationship.
Both ofγ 0 and γ 1 are not statistically significant in column c). 42 Thatthe orders of integration in the data for Japan, Britain and the United States are all 1, I
do not employ PSS test and directly estimate the error correction model.
41 I assume that Japanese interest rates do not have influence on British rates because
Japan was a small economy, and that there are no simultaneous biases. That
assumption is also applied in Obstfeld and Taylor [2004] and Obstfeld, Shambaugh, andTaylor [2004].
∆ R b ,t42 The result of the formula without the difference of the base rate in time t () in21

indicates weak responses in Japanese interest rate to American rate in the shorthorizon. Other coefficients are statistically significant and have the expected signs. The
coefficient of error correction term or the adjustment speed, ω , has the absolute valueof .06, indicating that the half-life of the initial disturbing shock to the long-run
relationship is 12 months.
I also conduct a regression including dummy variables in the error correction
term, because cointegration tests indicate the existence of a structural change. The
formula is expressed by equation (3).

∆Rt = α + ∑ β j ∆Rt − j + ∑ γ j ∆Rb ,t − j + ω (σ + σ Π Dt + Rt −1 − [θRb ,t −1 + θ Π Rb ,t −1 Dt ]) + u t , (3)
p

p

j =1

j =0

Dt has a value of zero before and in December 1932, and a value of one afterwards.
The result with the dummy variables is reported in the fourth column, d). Bothofγ 0 and γ 1 are not statistically significant. Other coefficients are statisticallysignificant and have the expected signs. The coefficient of error correction term or the
adjustment speed, ω , has the absolute value of .012, indicating that the half-life of theinitial disturbing shock to the long-run relationship is 5 months.
The dummy variable for the cointegrating slope coefficient, θ Π , is statisticallysignificant, indicating a change in long-term relationship between Japanese andAmerican interest rates at the end of 1932. According to the regression result, the valueof the cointegrating slope coefficient before and in December 1932, θ , is .253, and thatafter January 1933, θ + θ Π , is .077. That indicates the level relationship between
Japanese and American interest rates weakened at the end of 1932.
The cointegrating slope coefficients for American interest rate before and after
the end of 1932 are smaller than that for British rate. The adjustment speed ofJapanese interest rate to the disturbance in the American rate is higher than in the

explanatory variables is not reported. The result is similar to that reported in column c).
22

British rate if one assumes the structural change in the level relationship.

(4) Interpretation and Discussion
The quantitative analyses complement the narrative ones. The quantitative
analyses indicate that Japanese long-term interest rate held a long-run relationshipwith British rate through the interwar period. The Japanese long-term interest rate
held a long-run relationship also with American rate, but the relationship was
weakened at around the end of 1932 or the beginning of 1933.
The existence of a long-run relationship of Japanese interest rate with center
country’s rates through the interwar period suggests the enduring influence of the gold
standard. 43 Japanese policymakers were not free from the Golden Fetters after
formally departing from the gold standard. They were not able to pursue monetary
policy independent from the international capital markets. The choice for Japanesepolicymakers in the beginning of 1930s was NOT whether to peg or to float theircurrency; rather the choice was to what and at which level to peg their currency.
Japanese policymakers decided to peg the pound-sterling.44 That implied that
the Japanese monetary policy was to be dependent on the British monetary policy. It
was a right decision, given the early departure of Britain from the gold standard andthe greater possibility for easy monetary policy in Britain than in the United States.
And that decision contributed early recovery of Japanese economy. Takahashi and hiscolleagues contributed to early recovery of Japanese economy, not because they pursued
independent monetary policy, rather, because they followed easy monetary policy of

One might argue that such a relationship could be the result of synchronization ofbusiness cycles rather than the result of currency peg. I do not exclude such a possibility,
but narratives indicate the importance of currency peg rather than synchronization ofbusiness cycles.
44 In this regard, Japan can be classified de-facto in pound-sterling bloc after the
breakdown of the international gold standard.
43

23

Britain.
Japan was a small and open economy in the interwar period. Japan wasindebted to foreign investors for foreign-denominated debts. Japan needed to earn
foreign money to service its debts. The one-shot devaluation of the currency was a
possible policy choice. On the other hand, Japan needed to avoid capital flight in the
midst of the international financial crisis. Imposing capital control was another choice.
Still, Japan had to show the credibility of its policy and currency to the international
investors.
Hamilton [1988] describes the destructive power of international capital flows
during the final stage of the gold standard. In such a situation, the policy choice for thepolicymakers in a small and open economy was limited. They needed to peg theircurrency to some other currency at a level that would be appropriate under thecircumstances.
The Japanese experience during the interwar period is different from thestandard Keynesian explanation of a closed economy. Rather, the story resembles the
emerging economies in the currency crisis of late 1990s. Once forced to depart from apeg system by the contagious effect of international capital flows, the policymakers
devalued their currency in one shot, and then tried to stabilize the currency at the new,equilibrium level. In doing so, the policymakers continued to pay attention to theinternational financial market.
I add a notation about the timing of the structural change in the long-run
relationship between Japanese and American interest rates. There are two events
which might be associated with the structural change. One possibility is the start of theunderwriting of new issues of government bonds by BOJ in November 1932. Bank ofJapan drastically increased the amount of open market operation by means ofgovernment bonds around the end of 1932. Another possibility is the economic
24

turbulence in the United States in the beginning of 1933 which eventually led to theAmerican departure from the gold standard.
It is reasonable to assume that the structural change with the American rate
was associated with the American event rather than the Japanese domestic event. If
one assume that the Japanese domestic events, such as the start of BOJ underwriting ofgovernment bonds was the cause of structural change with the American rate, then theevent would cause a similar structural change to the relationship with the British rate.
I find no such structural change with the British rate.
So far, I have set aside the conduct of fiscal policy. I will explore it in future
study.

7. Concluding Remarks
I have found evidence of the enduring effects of the gold standard after the
departure of Japan in December 1931, as before the return in January 1930, both inqualitative materials and quantitative data. During the gold standard period in 1930-31
and during the suspension period in the 1920s, Japanese policymakers sacrificed
monetary policy autonomy in order to stabilize the exchange rate and to maintain freecapital movements. In 1932, the policymakers followed the decline in foreign interest
rates rather than conducted an autonomous monetary policy even after departing fromthe gold standard.
In theory, a national policymaker is able to conduct autonomous monetary
policy under the flexible exchange rate system. In reality, Japanese policymakers
seemed to be still obsessed by the Golden Fetters even after departing from the gold
standard. Japan experienced a decline in its long-term interest rate without closing its
domestic capital market. Rather, the policymakers followed the developments in theinternational market.
25

References
Aoki, Suiichi, Futsu Ginko Kashidashi Gyomu (The Procedures of Lending at Ordinary
Banks), Shi-Bun Shoin, 1932 (in Japanese).
Bagehot, Walter, Lombard Street, Henry S. King and Co., 1873.
Bank of Japan, Nihon Kin’yu-Shi Shiryo: Showa-Hen (Materials of Japan’s Financial
History: Showa Edition), Vol. 21, 1968 (in Japanese).
Bank of Japan, Nihon Kin’yu Men’pyo (Financial Chronology of Japan), 1997 (inJapanese).
Cha, Myung Soo, “Did Takahashi Korekiyo Rescue Japan from the Great Depression?”

The Journal of Economic History, 2003.
Cho, Yukio, Showa Kyoko (Showa Depression), Iwanami Shoten, 1973, reprinted 2001
(in Japanese).
Eichengreen, Barry, Golden Fetters, Oxford University Press, 1995.
Eichengreen, Barry, and Jeffrey Sachs, “Exchange Rates and Economic Recovery in the
1930s,” Journal of Economic History, 1985.
Engle, Robert F., and C. W. J. Granger, “Co-Integtation and Error Correction:
Representation, Estimation, and Testing,” Econometrica, 1987.
Fukai, Eigo, “Recent Monetary Policy of Japan,” The Lessons of Monetary Experience:

Essays in Honor of Irving Fisher, George Allen & Unwin Ltd., 1937.
Fukai, Eigo, Kaiko Nanajunen (Reflections on Seventy Years), Iwanami Shoten, 1941
(in Japanese).
Fuller, W. A., Introduction to Statistical Time Series, 2nd ed., Wiley, 1996.
Gregory, Allan W., and Bruce E. Hansen, “Residual-Based Tests for Cointegration in
Models with Regime Shifts,” Journal of Econometrics, 1996.
Hamilton, James D., “Role of the International Gold Standard in Propagating the Great
Depression,” Contemporary Policy Issues, 6, 1988.
26

Ito, Masanao, Nihon no Taigai Kin’yu to Kin’yu Seisaku: 1914-1936 (Japan’s Overseas
Finances and Monetary Policies: 1914-1936), The University of Nagoya Press, 1989
(in Japanese).
Keynes, John Maynard, General Theory of Employment, Interest and Money,
Macmillan and Co., ltd., 1936.
Kindleberger, Charles P., The World in Depression, 1929-1939, Allen Lane, 1973.
Komiya, Ryutaro, and Miyako Suda, Gendai Kokusai Kin’yu-Ron: Rekishi Seisaku-Hen(Contemporary International Finance: History and Policies), Nihon Keizai
Shinbun-Sha, 1983 (in Japanese).
MacKinnon, James G., “Numerical Distribution Functions for Unit Root andCointegration Tests,” Journal of Applied Econometrics, 11-6, pp.601-618, 1996.
Miwa, Ryoichi, “Keizai Seisaku Taikei (Economic Policy Formula),” Socio-Economic
Society ed., 1930 Nendai no Nihon Keizai (The Japanese Economy in the 1930s),
University of Tokyo Press, 1982.
Nakamura, Takafusa, Senzen-Ki Nihon Keizai Seicho no Bunseki (Economic Growth in
Prewar Japan), Iwanami Shoten, 1971 (in Japanese; translated into English by A.
R. Feldman, Yale University Press, 1983).
Nanto, Dick K., and Shinji Takagi, “Korekiyo Takahashi and Japan’s Recovery from theGreat Depression,” The American Economic Review, 75-3, pp.369-374, 1985.
Obstfeld, Maurice, Jay C. Shambaugh, and Alan M. Taylor, “Monetary Sovereignty,
Exchange Rates, and Capital Controls: The Trilemma in the Interwar Period,” IMF

Staff Papers, Vol.51, Special Issue, International Monetary Fund, 2004.
Obstfeld, Maurice, and Alan M. Taylor, “The Great Depression as a Watershed:
International Capital Mobility over the Long Run,” NBER Working Paper 5960,
1997.
Obstfeld, Maurice, and Alan M. Taylor, Global Capital Markets: Integration, Crisis, and27

Growth, Cambridge University Press, 2004.
Osaka

Bankers

Association,

Osaka

Ginko

Tsushin-Roku(OsakaBankers

Correspondence), various issues (in Japanese).
Patrick, Hugh T, “The Economic Muddle of the 1920’s,” Morley, James William, ed.,Dilenmas of Growth in Prewar Japan, Princeton University Press, 1971.
Phillips, P. C. B., and S. Ouliaris, “Asymptotic Properties of Residual Based Tests for
Cointegration,” Econometrica, 58-1, 165-193, 1990.
Sano, Houji, Sho-sho Kashitsuke Jimu (The Procedures of Lending with a Certificate),
Bun-Ga Do, 1936 (in Japanese).
Stock, James H., and Mark W. Watson, “A Simple Estimator of Cointegrating Vectors in
Higher Order Integrated Systems,” Econometrica, 61-4, 1993, pp.783-820.
Juichi Tsushima, “Kin Kaikin no Butai Ura (Behind the Curtain of the Lifting of theGold Embargo),” Ando, Yoshio, ed., Showa Keizai Shi eno Shogen (Testimonies for
the Economic History of Showa Era), vol.1, 1965.

28

Figure 1. Exchange Rates(Oct. 1897=100)
160

return to
gold(Jan. 1930)

140(yen appreciated)

120
100
80
60
40
departure from
gold
(Dec. 1931)

20
0
28/01

30/01

32/01

(yen depreciated)

34/01

yen/dollar

yen/pound-sterlingsource: Ministry of Finance, Reference Book of Financial Matters.

29

36/01

Figure 2. Price Indexes(1934-36=100)
140
120
100
80
60
40
20

departure from gold
(Dec. 1931)

return to gold
(Jan. 1930)

0
28/01

29/01

30/01

31/01

Wholesale Price Index

32/01

33/01

34/01

Retail Price Index

sources: Bank of Japan; Oriental Economist.

30

35/01

36/01

Stock Price IndexFigure 3. Interest Rates
percent
10

8

6

4

2

return to gold
(Jan. 1930)

0
28/01

29/01

30/01

departure from gold
(Dec. 1931)

31/01

official discount rate

32/01

33/01

bills discounted

34/01

35/01

36/01

certificates of lending

Sources: Bank of Japan; Tokyo Bankers Association.
note: Bills discounted and certificates of lending are reported by members of Tokyo Bankers

Association.

31

Figure 4. Money
12000

120
return to gold
(Jan. 1930)

departure from gold
(Dec. 1931)

100

10000

80

8000

60
28/01 29/01 30/01 31/01 32/01 33/01 34/01 35/01 36/01

6000

M1(1934-36=100, left scale)Bank Deposit (million, right scale)source: Bank of Japan32

Figure 5. Short-term Interest Rates
12

percent
return to gold, Japan(Jan. 1930)

departure from gold, Japan(Dec. 1931)

10

8

6

4

2

0
1919

1925
Japan

1930
Britain

1935

1938

United States

Sources: Tokyo Bankers Association;
NBER, Macrohistory Database, http://nber.org/databases/macrohistory/contents/.
Note: Data are interest rates on "bills discounted" for Japan and Britain, and on"commercial papers" for the United States.

33

Figure 6. Long-term Interest Rates
percent
7

departure from gold,
Japan(Dec. 1931)

return to gold, Japan(Jan. 1930)
6

5

4

3

2
1919

1925

1930
Japan

Britain

1935

1938

US

Sources: Tokyo Stock Exchange, Monthly Report ; Nomura Securities, Annual Reporton Public and Cooperate Securities ;NBER, Macrohistory Database , http://nber.org/databases/macrohistory/contents/;
Board of Governors of the Federal Reserve System, Banking and Monetary Statistics .

34

Table 1. Unit Root Tests for Short-term Interest RatesJapan(level)ADF
PP(first differnce)
ADF
PP(Sample period: Jan.1919-Dec.1938; Number of observations: 240)bills discounted

certificates of lending-3.710 **-3.929 **(9)-4.054 ***-4.236 ***(5)-5.560 ***-10.948 ***(8)-4.134 ***-18.032 ***(5)Britain and the Unites States
Britain (bills discounted)(level)(2)
ADF-3.549 **PP-3.027(first difference)(4)
ADF-6.836 ***PP-11.006 ***United States (commercial papers)-2.832-2.742(1)-9.982 ***-10.035 ***(0)Notes: 1.Tests are employed on the formula with a constant and a trend term for level data, and without them for first difference data.
2."***", "**" and "*" indicate rejection of a unit root in 1, 5, and 10 percent level of significance, respectively.
3.numbers in parenthesis indicate lag orders for ADF tests. The lag orders are determined by being iteratively reduced from 12
to the order at which the longest lag term is statistically significant.
4.The critical values are from Table 10.A.2 of Fuller[1996] for ADF tests, and from Mackinnon[1996] for PP tests.

35

Table 2. Unit Root Tests for Long-term Interest Rates(Sample period: Jan.1919-Dec.1938; Number of observations: 240)Japan
(level)ADF
PP(first differnce)
ADF
PP

Britain

United States-2.865-3.200 *(11)-2.931-2.738(12)-3.007-2.832(9)-5.836 ***-11.225 ***(10)-4.099 ***-14.516 ***(11)-4.589 ***-11.588 ***(8)Notes: 1.Tests are employed on the formula with a constant and a trend term for level data, and without them for first difference data.
2."***", "**" and "*" indicate rejection of a unit root in 1, 5, and 10 percent level of significance, respectively.
3.numbers in parenthesis indicate lag orders for ADF tests. The lag orders are determined by being iteratively reduced from 12
to the order at which the longest lag term is statistically significant.
4.The critical values are from Table 10.A.2 of Fuller[1996] for ADF tests, and from Mackinnon[1996] for PP tests.

36

Table 3. Granger Causality Tests (F-Statistics)
Dependent Valiable Japan
Britain
United States
United States Japan
United States Japan
Britain
Independent ValirablBritain
Max lags
1
4.94 **
6.17 **
0.96
16.82 ***
0.99
17.89 ***
2
13.87 ***
11.58 ***
4.70 **
19.10 ***
8.71 ***
28.03 ***
3
12.89 ***
10.89 ***
9.93 ***
20.78 ***
8.61 ***
29.32 ***
4
12.69 ***
11.92 ***
11.57 ***
21.47 ***
8.14 ***
35.34 ***
5
13.16 ***
18.53 ***
12.62 ***
23.33 ***
8.50 ***
36.73 ***
6
17.06 ***
18.78 ***
17.63 ***
32.43 ***
13.49 ***
44.07 ***
Notes: 1.Tests are employed with the formula including self-lags, which are not reported in the table.
2."***"and "**" indicate statistical significance at 1 and 5 percent level, respectively.

37

Table 4. Cointegration Tests (Engle-Granger)
Dependent variable: Japan ("Ko-go" 5 percent bond for the long-term interest rate, bills discounted for the short-term interest rate)
Independent variables: Constant term and Great Britain (Consols/bills discounted) / Constant term and United States (Treasury)
Sample period: January 1919-December 1938, Number of observations: 240

Long-tern interest rate
Britain (Consols)
ADF statistics-2.902( 1)**

United States (Treasury)-1.949( 11 )

Short-term interest rate
Britain (Bills Discounted)-2.313( 2)

Notes: 1. The table shows the results of ADF tests on the residuals of ordinary least square regressions (the Engle-Granger test).
The ordinary least square regressions are conducted in the formula below:

R t + µ + λ R b,t + et ,2. The critical values are from Table IIa of Phillips and Ouliaris [1990]. "**" indicates statistical significance at 5 percent level.
3. Figures in parentheses show the lag order. The lag orders are determined by being iteratively reduced from 12
to the order at which the longest lag term is statistically significant.

38

Table 5. Cointegration Tests with A Structural Change (Gregory-Hansen)
Dependent variable: Japan ("Ko-go" 5 percent bond)
Independent variables: Constant term and United States (Treasury)
Sample period: January 1919-December 1938, Number of observations: 240

United States (Treasury)
ADF*
*
Zt
*
Za

-4.817 +-4.701 +-38.642[ Dec. 1932 ][ Jan. 1933 ]--Notes: 1. The table shows residual-based cointegration test statistics of "regime change" (C/S) presented by Gregory and Hansen (1996).
The "regime change" (C/S) is described as below;

Rt = µ1 + µ2 Dt + λ1Rb,t + λ2 Rb,t Dt + et ,Dt has a value of zero before and at the time of the structural change; D t has a value of one after the structural change.
2. Dates in brackets show the time points when the structural change occurs.
3. The critical values are from Table I of Gragory and Hansen [1996]. "+" indicates statistical significance at 10 percent level.

39

Table 6. Estimation Results of Japanese Interest Rate on International Base Rate (Error Correction Model)
Dependent variable: Japan ("Ko-go" 5 percent bond)∆Rt = α + ∑ β j ∆Rt − j + ∑ γ j ∆Rb ,t − j + ω (σ + Rt −1 − θRb,t −1 ) + u t ,Estimation formula in column a), b), and c):

p

p

j =1

j =0

∆Rt = α + ∑ β j ∆Rt − j + ∑ γ j ∆Rb,t − j + ω (σ + σ Π Dt + Rt −1 − [θRb ,t −1 + θ Π Rb,t −1 Dt ]) + u t ,in column d):

p

p

j =1

j =0

Sample period: January 1919-December 1938, Number of observations: 240

α
β1
γ0
γ1

Rb: Britain (Consols)a)-0.001 ( -0.30 )0.287 ( 4.72 ) ***0.115 ( 2.44 ) **0.053 ( 1.08 )b)-0.0020.299-0.057ω
half-life-0.070
9.61

σ
σΠ
θ
θΠ
adj. R2(-0.38 )
4.89 )-1.14 )

-0.0749.01(-3.79 )***

(cointegrating vector)-3.161 ( -39.63 ) ***--0.549 ( 28.54 ) ***----3.161-0.549--( -39.63 )-( 28.54 )
--

***

0.171

0.153

( -3.59 )

***

(
(

***

***

Rb: United States (Treasury)c)d)-0.002 ( -0.41 )-0.0020.322 ( 5.25 ) ***0.358
0.060 ( 1.24 )0.052-0.055 ( -1.12 )-0.062-0.05612.00(-3.39 )***

(cointegrating vector)-3.693 ( -46.36 ) ***--0.476 ( 22.40 ) ***--0.127((((-0.42 )
5.90 ) ***1.09 )-1.31 )

-0.123
5.27(-4.96 ) ***-4.6810.068
0.253-0.176( -56.20 ) ***(0.33 )( 12.36 ) ***( -2.52 ) **0.171

Notes: 1. Figures in parentheses are t-statistics.
"***", "**", and "*" indicate statistical significance at 1 percent, 5 percent, and 10 percent levels, respectively.
2.D t has a value of zero before and in December 1932; otherwise, D t has a value of one.
3. In all cases of the error correction model estimation, lag orders are chosen to be 1 by Schwarz information criteria.
4."Half-life" means the half-life of the shock based on the adjustment speed, ω.
5.Cointegrating vectors are calculated by the dynamic OLS method. Lag orders are chosen by Schwarz infromation criteria.

40