Myths and Observations on Unconventional Monetary Policy -- Takeaways from Post-Bubble Japan --

Reservations are sometimes raised regarding the effectiveness of unconventional monetary policy (UMP) due to the concerns about influences of impaired financial systems and low policy rates. To see if this is the case, we combine the local projection method of Jorda (2005) with shadow rates to estimate macroeconomic effects of monetary policy shocks during the implementation period of UMP, and test if effects of these shocks with the same magnitude differ across periods or states of the economy, using Japan's data from the 1980s to 2016. We find that monetary policy shocks during the implementation period of the UMP had statistically significant expansionary effects on the economy. We also find that an unexpected 100 basis point cut in shadow rates during the UMP yielded larger expansionary effects on key economic variables than it did during the conventional monetary policy (CMP), because of the following three reasons: (i) A cut in the shadow rates resulted in a larger reduction in the real interest rate, and affected a wider range of borrowing rates during the UMP; (ii) The effectiveness of monetary policy shocks was dampened when the financial system was significantly impaired, particularly during the CMP; (iii) Other things being equal, the effectiveness has been so far little affected by the level of policy rate. Our results show that UMP has been effective, but that the nature of monetary transmission is subject to change depending on financial conditions or other economic circumstances, and therefore monetary policy needs to be carefully implemented. Note also that our study only explores the effects of a one-unit shock to the monetary policy rule, and does not address the entire effects of monetary easing that are affected by the size of shocks as well.