Regime-Switching Approach to Monetary Policy Effects: Empirical Studies using a Smooth Transition Vector Autoregressive Model

Even though monetary policy has kept interest rates at historically low levels, the Japanese economy has experienced long lasting recessions since the 1990s. These recessions are commonly attributed to nominal interest rates coming up against the zero bound and to the delay in achieving necessary structural changes. However, since these two factors had not yet appeared in the early 1990s, there must also have been other factors acting to weaken the effectiveness of monetary policy. In this paper, we employ Japanese data to conduct an empirical analysis of changes in the effect of monetary policy on the real economy. We find that monetary policy effects vary depending on the phase of the business cycle (measured in terms of the rate of change in real output) and the lending attitudes DI. More precisely, policy effects are larger in recession but diminish in extreme recession, and monetary policy is more effective when lenders' attitudes are severe but less effective when they are excessively severe.