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Liquidity Trap and the Stability of Money Demand: Is Japan Really Trapped at the Zero Bound?

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  • Ryuzo Miyao

    (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)

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    Abstract

    Is the Japanese economy really trapped at the zero interest rate bound? The question seems particularly important because recent theoretical discussions on liquidity traps suggest that undesirable dynamics such as "deflationary spiral" are likely to occur when the economy reaches the lower zero bound. This paper attempts to answer the above question by analyzing the stability of an equilibrium money demand relationship in Japan. Specifically, it performs a formal analysis on the presence and stability of cointegration in M1 demand in Japan and argues that the answer seems negative. With the double-log specification, a cointegrating M1 relationship exists and is found to be stable (i.e. no break in the interest elasticity) even after 1995 when nominal rates were lowered to a decimal point level or virtually "zero percent".

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    File URL: http://www.rieb.kobe-u.ac.jp/academic/ra/dp/English/dp127.pdf
    File Function: First version, 2002
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    Bibliographic Info

    Paper provided by Research Institute for Economics & Business Administration, Kobe University in its series Discussion Paper Series with number 127.

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    Length: 20 pages
    Date of creation: Oct 2002
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    Handle: RePEc:kob:dpaper:127

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    1. Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
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    5. Fujiki, Hiroshi, 2002. "Money Demand near Zero Interest Rate: Evidence from Regional Data," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 20(2), pages 25-41, April.
    6. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "The Perils of Taylor Rules," CEPR Discussion Papers 2314, C.E.P.R. Discussion Papers.
    7. Krugman, Paul, 2000. "Thinking About the Liquidity Trap," Journal of the Japanese and International Economies, Elsevier, vol. 14(4), pages 221-237, December.
    8. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1999. "Avoiding Liquidity Traps," Working Papers, C.V. Starr Center for Applied Economics, New York University 99-21, C.V. Starr Center for Applied Economics, New York University.
    9. Miyao, Ryuzo, 2000. "The Role of Monetary Policy in Japan: A Break in the 1990s?," Journal of the Japanese and International Economies, Elsevier, vol. 14(4), pages 366-384, December.
    10. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
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    14. Gregory, Allan W. & Hansen, Bruce E., 1996. "Residual-based tests for cointegration in models with regime shifts," Journal of Econometrics, Elsevier, Elsevier, vol. 70(1), pages 99-126, January.
    15. Willem H Buiter & Nikolaos Panigirtzoglou, 2000. "Liquidity traps: how to avoid them and how to escape them," Bank of England working papers 111, Bank of England.
    16. Hondroyiannis, George & Swamy, P. A. V. B. & Tavlas, George S., 2000. "Is the Japanese economy in a liquidity trap?," Economics Letters, Elsevier, vol. 66(1), pages 17-23, January.
    17. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
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    20. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 231-254.
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    Cited by:
    1. Assenmacher-Wesche, Katrin & Gerlach, Stefan & Sekine, Toshitaka, 2007. "Monetary factors and inflation in Japan," IMFS Working Paper Series 13, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
    2. Laurence M. Ball, 2006. "Fiscal Remedies for Japan’s Slump," NBER Chapters, in: Monetary Policy with Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 279-306 National Bureau of Economic Research, Inc.
    3. Ryuzo Miyao, 2004. "Use of Money Supply in the Conduct of Japan's Monetary Policy: Reexamining the Time Series Evidence," Discussion Paper Series, Research Institute for Economics & Business Administration, Kobe University 163, Research Institute for Economics & Business Administration, Kobe University.
    4. Inagaki, Kazuyuki, 2009. "Estimating the interest rate semi-elasticity of the demand for money in low interest rate environments," Economic Modelling, Elsevier, vol. 26(1), pages 147-154, January.
    5. Nakashima, Kiyotaka & Saito, Makoto, 2012. "On the comparison of alternative specifications for money demand: The case of extremely low interest rate regimes in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 26(3), pages 454-471.

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