The Liquidity Trap: Evidence from Japan
Japanese economic activity has been stagnant since the collapse of the speculative asset-price bubble in 1990, despite highly expansionary monetary policy which has brought interest rates down to record low levels. Although several reasons have been put forward to explain the sustained weakness of the Japanese economy, none is more intriguing from the viewpoint of a central bank than the possibility that monetary policy had been largely ineffective because the Japanese economy entered a Keynesian "liquidity trap." According to Keynes, the monetary authority would be unable to reduce interest rates below a non-zero positive interest rate floor if market participants believed that interest rates had reached bottom. Any subsequent monetary expansion, then, would lead investors to increase their holdings of idle cash balances and to become net sellers of government bonds. This paper provides evidence on whether the Japanese economy entered a "liquidity trap" in the recent period, based on a money-demand framework. A Markov regime-switching approach is also used to determine whether the more recent response of money demand to interest rates can be characterized as a separate regime. In general, we do not find any support for the liquidity trap hypothesis. Moreover, we cannot conclude that the response of the demand for money to changes in interest rates was significantly different than in the past. However, we do find that through history the magnitude of the response of money demand to changes in interest rates has been relatively smaller in Japan, suggesting that traditional money demand relationships may not hold.
|Date of creation:||1997|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/
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.:
- Schwert, G William, 1989.
"Tests for Unit Roots: A Monte Carlo Investigation,"
Journal of Business & Economic Statistics,
American Statistical Association, vol. 7(2), pages 147-59, April.
- Barth, James R & Kraft, Arthur & Kraft, John, 1976. "Estimation of the Liquidity Trap Using Spline Functions," The Review of Economics and Statistics, MIT Press, vol. 58(2), pages 218-22, May.
- White, Kenneth J, 1972. "Estimation of the Liquidity Trap with a Generalized Functional Form," Econometrica, Econometric Society, vol. 40(1), pages 193-99, January.
- Pifer, Howard W, 1969. "A Nonlinear, Maximum Likelihood Estimate of the Liquidity Trap," Econometrica, Econometric Society, vol. 37(2), pages 324-32, April.
- GRANDMONT, Jean-Michel & LAROQUE, GUY, .
"The liquidity trap,"
CORE Discussion Papers RP
-240, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Simon van Norden & Huntley Schaller & ), 1995.
"Speculative Behaviour, Regime-Switching, and Stock Market Crashes,"
- Van Norden, S. & Schaller, H., 1996. "Speculative Behaviour, Regime-Switching and Stock Market Crashes," Working Papers 96-13, Bank of Canada.
- Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
- Spitzer, John J, 1976. "The Demand for Money, the Liquidity Trap, and Functional Forms," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 17(1), pages 220-27, February.
- Simon van Norden & Robert Vigfusson, 1996.
"Regime-Switching Models: A Guide to the Bank of Canada Gauss Procedures,"
- Van Norden, S. & Vigfusson, R., 1996. "Regime-Switching Models, A guide to the Bank of Canada Gauss Procedures," Working Papers 96-3, Bank of Canada.
- Robert Vigfusson, 1996.
"Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach,"
- Vigfusson, Robert, 1997. "Switching between Chartists and Fundamentalists: A Markov Regime-Switching Approach," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(4), pages 291-305, October.
- Vigfusson, R., 1996. "Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach," Working Papers 96-1, Bank of Canada.
- Goldfeld, Stephen M. & Quandt, Richard E., 1973. "A Markov model for switching regressions," Journal of Econometrics, Elsevier, vol. 1(1), pages 3-15, March.
- Eisner, Robert, 1971. "Non-Linear Estimates of the Liquidity Trap," Econometrica, Econometric Society, vol. 39(5), pages 861-64, September.
When requesting a correction, please mention this item's handle: RePEc:bca:bocawp:97-4. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.