The ‘internal financing mechanism’ and (hyper)inflation in the wartime Japanese Empire

Abstract

To sustain a protracted war after losing foreign loans and reserves and being sanctioned by the Allies, Japan used its ‘internal financing mechanism’ to gobble up civilian capital through government bonds, unbacked paper currency and interest rate interventions. These tactics aggrandised the size of the monetary base and money supply in Japan’s home islands and colonies, but also created inflationary pressures. To minimise the risk of (hyper)inflation, the government encouraged civilians to save in order to enrich the capital of financial intermediaries who would then absorb the ever-increasing government bonds. The ideal failed as monetary expansion outstripped economic productivity, even though expansionary monetary policy had to be tolerable in order to supply sufficient credit for war production. Imperial Japan’s use of unsecured credit to finance the war, together with its loose exchange controls, led to the diversion of colonial hyperinflationary pressures to the home islands, multiplying the risk of implosion of the ‘internal financing mechanism’. Although draconian currency controls were subsequently introduced, they further disrupted the empire’s economic order, and eventually led to the collapse of the yen bloc.