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Japan's Deflation, Problems in the Financial System, and Monetary Policy

  • Baba, Naohiko

    (Bank of Japan)

  • Nishioka, Shinichi

    (Bank of Japan)

  • Oda, Nobuyuki

    (Bank of Japan)

  • Shirakawa, Masaaki

    (Bank of Japan)

  • Ueda, Kazuo

    (Bank of Japan)

  • Ugai, Hiroshi

    (Bank of Japan)

This paper offers three analyses of Japan's macroeconomic experience during the post-1990 period. First, we analyze various facets of deflation during the period, arguing that the deflation of general prices has by no means been a major factor for the stagnating economy. In contrast, the deflation of asset prices was closely related to the economic difficulty of the period. In particular, the negative shocks generated by sharp declines in asset prices in the early 1990s have been propagated and amplified by their interaction with the deterioration in the condition of the financial system. Some statistical evidence supports this view. Second, we analyze the effects of monetary policy adopted by the Bank of Japan (BOJ) to fight deflation since the late 1990s. Given that short-term interest rates were already nearly zero in the mid-1990s, policy measures have focused on creating monetary easing effects beyond those created by zero interest rates alone. We show that the zero interest rate policy, which includes a commitment to maintain a zero interest rate for a longer period than that suggested by a baseline monetary policy rule, has produced strong effects on expected future short-term interest rates and thus the entire yield curve. Third, we argue that the BOJ has successfully prevented a repetition of the 1997-98 type liquidity crisis by directing market operations at addressing the financial-sector problems. These operations have taken the form of containing risk and liquidity premiums, particularly in the money market, through proactive provision of liquidity as well as the BOJ's own risk- taking activity.

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Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 23 (2005)
Issue (Month): 1 (February)
Pages: 47-111

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Handle: RePEc:ime:imemes:v:23:y:2005:i:1:p:47-111
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  1. Glenn D. Rudebusch & Tao Wu, 2003. "A macro-finance model of the term structure, monetary policy, and the economy," Working Paper Series 2003-17, Federal Reserve Bank of San Francisco.
  2. Fumio Hayashi & Edward C. Prescott, 2000. "The 1990s in Japan: a lost decade," Working Papers 607, Federal Reserve Bank of Minneapolis.
  3. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
  4. Yasuo Hirose & Koichiro Kamada, 2002. "Time-Varying NAIRU and Potential Growth in Japan," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
  5. Masayuki Nakakuki & Akira Otani & Shigenori Shiratsuka, 2004. "Distortions in Factor Markets and Structural Adjustments in the Economy," Hi-Stat Discussion Paper Series d04-26, Institute of Economic Research, Hitotsubashi University.
  6. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  7. Masaaki Shirakawa, 2001. "Monetary Policy Under the Zero Interest Rate Constraint and Balance Sheet Adjustment," Bank of Japan Research Papers 2001-05, Bank of Japan.
  8. Koichiro Kamada & Naohisa Hirakata, 2002. "Import Penetration and Consumer Prices," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
  9. Michael J. Fleming & Kenneth D. Garbade, 2004. "Repurchase agreements with negative interest rates," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 10(Apr).
  10. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  11. Fumio Hayashi & Edward C. Prescott, 2002. "Data Appendix to The 1990s in Japan: A Lost Decade," Technical Appendices hayashi02, Review of Economic Dynamics.
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