Central Banknotes and Black Markets: The Case of the Japanese Economy During and Immediately After World War II

Employing the Japanese case of large-scale black marketsBlack market under extensive price controls during and immediately after World War II, we first explore how much income leaked out of the formal economy into the black markets. Then, we investigate the extent to which the circulation of Bank of Japan (BOJ) notesBank of Japan (BOJ) note helped the leaked income to flow back into the formal economy when the notes were held as an instrument to conceal illicit income by the black marketeers. According to our estimates, 6–30% of national income leaked into the black markets in the above period, while more than 40% of the leaked income returned to the treasury as massive seigniorage revenues in the last years of the war. Inflation was not too high during the war because of the black marketeers’ strong money demand. After the war, however, the black marketeers shifted their portfolios from BOJ notes to physical assets and land, thereby reducing their money demand and accelerating inflation. We also demonstrate that the black markets helped to reserve scarce physical resources for the post-control economy starting in the late 1940s.