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Monetary Policy in a Liquidity Trap: What Have We Learned, and to What End?

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  • Ippei Fujiwara
  • Naoko Hara
  • Naohisa Hirakata
  • Shinichiro Watanabe
  • Kentaro Yoshimura

Abstract

Reflecting recent economic developments in Japan, there is a growing interest in how monetary policy should be conducted under low inflation and nominal interest rates. Among several proposed solutions, the conventional wisdom seems to be to commit to lower future short‐term nominal interest rates through some variation on price‐level targeting. We confirm the effectiveness of such a policy in a large‐scale dynamic general equilibrium model: the Japanese Economic Model. However, uncertainty – which affects how monetary policy should be conducted – increases in the presence of the zero bound on nominal interest rates. We posit that the increased uncertainty may explain why the central bank cannot fully commit to a certain fully specified policy scheme far into the future when the economy is caught in a liquidity trap.

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  • Ippei Fujiwara & Naoko Hara & Naohisa Hirakata & Shinichiro Watanabe & Kentaro Yoshimura, 2005. "Monetary Policy in a Liquidity Trap: What Have We Learned, and to What End?," International Finance, Wiley Blackwell, vol. 8(3), pages 471-508, December.
    • Handle: RePEc:bla:intfin:v:8:y:2005:i:3:p:471-508
    DOI: 10.1111/j.1468-2362.2005.00167.x
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    2. Peter J. Morgan, 2012. "The Role and Effectiveness of Unconventional Monetary Policy," Chapters, in: Masahiro Kawai & Peter J. Morgan & Shinji Takagi (ed.), Monetary and Currency Policy Management in Asia, chapter 2, Edward Elgar Publishing.
    3. Dieppe, Alistair & McAdam, Peter, 2006. "Monetary policy under a liquidity trap: Simulation evidence for the euro area," Journal of the Japanese and International Economies, Elsevier, vol. 20(3), pages 338-363, September.
    4. Hirose, Yasuo, 2007. "Sunspot fluctuations ulnder zero nominal interest rates," Economics Letters, Elsevier, vol. 97(1), pages 39-45, October.
    5. Bokor, László, 2007. "Optimality criteria of hybrid inflation-price level targeting," MPRA Paper 10278, University Library of Munich, Germany, revised Jul 2008.
    6. Fujiwara, Ippei & Hara, Naoko & Yoshimura, Kentaro, 2006. "Effectiveness of state-contingent monetary policy under a liquidity trap," Journal of the Japanese and International Economies, Elsevier, vol. 20(3), pages 364-379, September.

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