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Monetary Policy Framework and "Insurance Against Deflation"

Author

Listed:
  • Naoko Hara

    (Bank of Japan)

  • Takeshi Kimura

    (Bank of Japan)

  • Kunio Okina

    (Chuo University)

Abstract

Using the FRB/Global model on Japanese monetary policy in the early 1990s, Ahearne et al. (2002) argued that deflation could have been avoided in Japan if the BOJ had lowered short-term interest rates by a further 250 basis points at any time between 1991 and early-1995 as "insurance against deflation." That study raised interesting questions on how the central bank could offer "insurance against deflation" when the inflation rate is close to zero. However, the simulation by Ahearne et al. (2002) has some drawbacks: it assumes the central bank's commitment to permanent downward shift of the policy reaction function when policymakers are not sure what would happen, which is neither feasible nor credible. In this paper, we show alternative policy frameworks of "insurance against deflation" that can be feasible and credible even under uncertainty. The simulation using the Japanese Economic Model (JEM), a large-scale macroeconomic model of the Research and Statistics Department of the Bank of Japan, suggests that what is important is not large cuts in interest rates at an early stage; rather, the central bank would commit to cut interest rates aggressively in the future, if the risk of deflation increases.

Suggested Citation

  • Naoko Hara & Takeshi Kimura & Kunio Okina, 2008. "Monetary Policy Framework and "Insurance Against Deflation"," Bank of Japan Working Paper Series 08-E-6, Bank of Japan.
    • Handle: RePEc:boj:bojwps:08-e-6
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    File URL: http://www.boj.or.jp/en/research/wps_rev/wps_2008/data/wp08e06.pdf
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    References listed on IDEAS

    as
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    6. Fujiwara, Ippei & Hara, Naoko & Hirose, Yasuo & Teranishi, Yuki, 2005. "The Japanese Economic Model (JEM)," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(2), pages 61-142, May.
    7. Ippei Fujiwara & Naoko Hara & Naohisa Hirakata & Takeshi Kimura & Shinichiro Watanabe, 2007. "Japanese Monetary Policy during the Collapse of the Bubble Economy: A View of Policymaking under Uncertainty," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 25(2), pages 89-128, November.
    8. David L. Reifschneider & John C. Williams, 2000. "Three lessons for monetary policy in a low-inflation era," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 936-978.
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    12. Oda, Nobuyuki & Nagahata, Takashi, 2008. "On the function of the zero interest rate commitment: Monetary policy rules in the presence of the zero lower bound on interest rates," Journal of the Japanese and International Economies, Elsevier, vol. 22(1), pages 34-67, March.
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    Cited by:

    1. Hamada, Koichi & Okada, Yasushi, 2009. "Monetary and international factors behind Japan's lost decade," Journal of the Japanese and International Economies, Elsevier, vol. 23(2), pages 200-219, June.
    2. Mitsuru Katagiri, 2016. "Forward Guidance as a Monetary Policy Rule," Bank of Japan Working Paper Series 16-E-6, Bank of Japan.
    3. Kevin Clinton & Roberto Garcia-Saltos & Marianne Johnson & Ondrej Kamenik & Douglas Laxton, 2010. "International Deflation Risks under Alternative Macroeconomic Policies," NBER Chapters, in: Sticky Prices and Inflation Dynamics (NBER-TCER-CEPR), pages 140-177, National Bureau of Economic Research, Inc.

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