A ‘Second-Best’ Rationale to Deflationary Monetary Policy in Japan
AbstractThe Bank of Japan permitted a ten-year period of deflation (1995-2005) which appears to have ended in 2006. The deflation, as well as the preceding disinflation, adversely affected the financial and real sectors of the economy that in turn, made it difficult to recover from the collapse of asset prices in 1990 and 1991. Various ad hoc explanations have been offered to account for the deflation period. This paper offers a second-best explanation based on a two-player policy game between the Bank of Japan and the banking system in which the banking system relies on an accommodative policy of forgiveness and forbearance by the Ministry of Finance to deal with weak balance sheets. The paper does not explicitly model the Ministry of Finance preference function but incorporates the Bank of Japan’s perceived willingness of the Ministry to accommodate the banking system in the Bank’s reaction function. The model suggests that in the context of established deflationary expectations and large amounts of debt, the Bank of Japan explicitly regarded the level of debt as exceeding the socially optimal level, that Ministry of Finance forgiveness and forbearance contributed to this excess, and lacking an instrument to reverse deflationary expectations, the Bank of Japan employed deflation as a disciplining instrument to limit real debt.
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Bibliographic InfoPaper provided by University of Nevada, Reno, Department of Economics & University of Nevada, Reno , Department of Resource Economics in its series Working Papers with number 06-009.
Length: 22 pages
Date of creation: Dec 2006
Date of revision:
Monetary Policy; Deflation; Japan;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
- E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-02-10 (All new papers)
- NEP-CBA-2007-02-10 (Central Banking)
- NEP-MAC-2007-02-10 (Macroeconomics)
- NEP-MON-2007-02-10 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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