Matsukata Deflation
The monetary system of Meiji Japan was initially random and chaotic inheriting the gold, silver and copper
money system from the Edo period, minting new coins but also issuing inconvertible government notes.
There was no central bank, and the "National Bank" system was copied from the US which allowed officiallycertified private banks ("national banks") to issue currency notes provided that they held certain gold or
silver as reserves.
Japan was using gold and silver as true money. Any paper notes or currency that could be exchanged
freely for these precious metals (anyone can bring paper money to a bank or the government and get goldor silver with no questions asked) were called "convertible" notes and money with no such guarantee wascalled "inconvertible" one - just paper.
Before Matsukata's time, the government didn't have any guarantee of this kind so Japan was not on thegold standard although gold and silver were regarded as true money. Gold was internationally preferable
as Europe and the US were moving toward the international gold standard, but silver was more popular
for trade within Asia. So both metals were honored.
The problem of inconvertible money is government tends to spend too much (there is no restraint imposedby the limited gold reserve). In fact, the Meiji government often faced budget problems(revenue<expenditure) and issued government notes without gold or silver backing. The military
expenditure related to 1877 Saigo rebellion worsened the situation. By then, the National Bank Act wasrevised to require no gold reserves for issuing private money. All this was causing inflation.
In 1881, the outstanding stock of inconvertible government notes was 105.9 million yen, supplementary
government notes 14.5 million yen (issued to bridge the timing gap between tax collection and fiscalspending) and inconvertible National Bank notes 34.4 million, with the total inconvertible notes andcurrencies of 154.8 million yen. Against this, the government reserve of gold and silver (mostly silver) wasonly 5 million yen.
Matsukata's plan was to get rid of inconvertible money and replace it with money backed by government's
metal reserves (called specie). Not only that, he wanted the government to accumulate sufficient specie
money so it could exchange convertible money into gold or silver when demanded. This was to establish
the credibility of monetary policy and avoid inflation.
The only main way to do this was to cut budget expenditure and increase taxes, and create a budget
surplus. This surplus would be used to redeem (get rid of) inconvertible notes and accumulate specie
money at the government (there were also administrative techniques and tricks that would accelerate theredemption). Matsukata expected to eliminate inconvertible money within a few to several fiscal years
through fiscal squeeze and this was actually achieved - see attached table (fiscal year was July-June then).
In the first few years of Matsukata Deflation, government's sliver holding was tiny and there was virtuallyno gold reserve. Matsukata decided to wait until he was sure that his plan was on track before promulgating
the Convertible Currency Act. The act was thus enacted in 1884. (Government didn't have to hold metallic
reserve against paper money one-to-one; the ratio of one to three should be enough (as in the UK) but theact was unclear regarding the exact percentage requirement of reserves against paper money issued.)
Matsukata's budget austerity caused deflation and recession, business failures and hardship for farmers.
He regarded this as a painful but necessary step to stop inflation and set the Japanese economy on asound path. The creation of the Bank of Japan as the sole issuer of reserve-backed money in 1882 andthe transition to the full (international) gold standard in 1897 had the similar objective of making theJapanese macroeconomy more stable and competitive.
(Main source: 日本銀行百年史編纂委員会編『日本銀行百年史』：BOJ, The One Hundred Year History of
the Bank of Japan, published in 6 volumes in 1982-86.)[Information provided to Nicholas A. Silvers, Grayson School, PA, USA on May 2, 2023]