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On the role of monetary policy in a deflationary economy: The case of Japan

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  • Motoshige Itoh

    (Faculty of Economics, University of Tokyo)

  • Naoki Shimoi

    (CIRJE, Faculty of Economics, University of Tokyo)

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    Abstract

    In this paper we review the role of monetary policy for a country facing deflationary pressure based on the recent experience of the Japanese economy. We discuss economic background of inflation policy in Japan and analyze the impacts of the policy. Japanese economy is in a liquidity trap now. Two types of reasons were pointed out to be in liquidity traps. They are a real factor and a monetary factor. The former factor is the case analyzed by Krugman, where IS curve shifts due to structural reason such as aging of population. Under this condition a negative real interest rate is requested to escape from the liquidity trap. However, liquidity trap can also arise from monetary reason and the scenario of escape from the trap is different. We illustrate the case where deflationary expectation leads the economy to a liquidity trap. If it is necessary to utilize monetary policy for generating inflation expectation, we then need some explicit monetary policy rules, which is strong enough to escape from liquidity traps but at the same time which is effective to suppress unnecessary political pressure and to keep the independence of the central bank. Inflation targeting is a candidate for such a rule.

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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2000/2000cf90.pdf
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    Bibliographic Info

    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-90.

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    Length: 42 pages
    Date of creation: Sep 2000
    Date of revision:
    Handle: RePEc:tky:fseres:2000cf90

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    1. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
    2. Buiter, Willem H & Panigirtzoglou, Nikolaos, 1999. "Liquidity Traps: How to Avoid Them and How to Escape Them," CEPR Discussion Papers 2203, C.E.P.R. Discussion Papers.
    3. Fischer, Stanley, 1982. "Seigniorage and the Case for a National Money," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 295-313, April.
    4. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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    Cited by:
    1. Willem H. Buiter, 2003. "Deflation: Prevention and Cure," NBER Working Papers 9623, National Bureau of Economic Research, Inc.

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