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The Zero-Interest-Rate and the Role of the Exchange Rate for Monetary Policy in Japan

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Abstract

In this paper we study the role of the exchange rate in conducting monetary policy in an economy with near-zero nominal interest rates as experienced in Japan since the mid-1990s. Our analysis is based on an estimated model of Japan, the United States and the euro area with rational expectations and nominal rigidities. First, we provide a quantitative analysis of the impact of the zero bound on the effectiveness of interest rate policy in Japan in terms of stabilizing output and inflation. Then we evaluate three concrete proposals that focus on depreciation of the currency as a way to ameliorate the effect of the zero bound and evade a potential liquidity trap. Finally, we investigate the international consequences of these proposals.

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  • Guenter Coenen & Volker Wieland, 2003. "The Zero-Interest-Rate and the Role of the Exchange Rate for Monetary Policy in Japan," CFS Working Paper Series 2003/09, Center for Financial Studies.
  • Handle: RePEc:cfs:cfswop:wp200309
    Note: Prepared for the "Conference on the tenth anniversary of the Taylor rule" in the Carnegie-Rochester Conference Series on Public Policy, November 22-23, 2002. We are grateful for helpful comments by Ignazio Angeloni, Chris Erceg, Chris Gust, Bennett McCallum, Lars Svensson, Carl Walsh as well as seminar participants at the Carnegie-Rochester conference, the Bank of Canada, the London School of Economics and the European Central Bank. The opinions expressed are those of the authors and do not necessarily reflect views of the European Central Bank. Volker Wieland served as a consultant in the Directorate General Research at the European Central Bank while preparing this paper. Any errors are of course the sole responsibility of the authors.
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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.
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    11. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
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    Keywords

    monetary policy rules; zero interest rate bound; liquidity trap; rational expectations; nominal rigidities; exchange rates; monetary transmission.;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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