Monetary Policy Reaction to Uncertainty in Japan: Evidence from a Quantile-on-Quantile Interest Rate Rule

Japan’s episodes of lower bound of interest rates together with macroeconomic uncertainty for over the past two decades stands as a tremendous hurdle for the estimation of Taylor-type rule models. We demarcate our study from previous literature by conducting the estimations not only at various points on the conditional distribution of the interest rate but also at various quantiles of an additional regressor on top of inflation and output, viz., an uncertainty measure, by adopting a quantile nonseparable triangular system estimation. The results show that the reaction to uncertainty seems to have substituted the Bank’s reaction to inflation and output, lending support to the Brainard attenuation principle. In essence, faced with higher uncertainty, the monetary authority reacts by cutting (attenuating) its policy rate across all quantiles of uncertainty at all conditional quantiles of interest rate, with an increased response of the Bank of Japan to uncertainty at its lower quantiles when interest rate is at its lower conditional quantiles. A possible explanation is the greater concern of getting out from the lower bounds of interest rate.