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Could Japan Target the Price Level or Inflation - What Happens to Monetary Policy Effectiveness during Disinflation?

Listed author(s):
  • Aaron MEHROTRA

The aim of this paper is to study whether price level or inflation targeting would be appropriate monetary policy regimes for Japan. A necessary condition for such regimes is that the rate of interest remain a positive tool of monetary policy. Using VAR and SVAR approaches, we investigate whether changes in the real ex ante and the nominal interest rate are able to stimulate an economy with a low inflation rate or deflation. Both with perfect foresight and using backward-looking schemes to predict the future price level, monetary policy remains potent even with declining inflation rates. This is confirmed by the stability of the estimated system throughout the examination period. A tax on currency, or ’Gesell money’ would be a possible alternative for Japan in order to lower the zero interest rate floor. We also find that monetary expansion in terms of broad money, broadly defined liquidity and M2+CDs, can bring Japan back to positive inflation rates. This must be supported by a higher interest rate differential between components of broad and narrow money. Moreover, expansion of direct funding in terms of corporate bonds could be beneficial for output growth while the non-performing loans problem in the economy is being tackled. Importantly, these results indicate that monetary policy alone is not able to pull Japan out of deflation and that fiscal measures need to be implemented in unison with monetary policy.

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Paper provided by European University Institute in its series Economics Working Papers with number ECO2004/02.

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Date of creation: 2004
Handle: RePEc:eui:euiwps:eco2004/02
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  1. Favero, Carlo A., 2001. "Applied Macroeconometrics," OUP Catalogue, Oxford University Press, number 9780198296850, December.
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  7. Bernanke, Ben & Gertler, Mark & Gilchrist, Simon, 1996. "The Financial Accelerator and the Flight to Quality," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 1-15, February.
  8. Shinobu Nakagawa & Kazuo Oshima, 2000. "Does a Decrease in the Real Interest Rate Actually Stimulate Personal Consumption? - An Empirical Study -," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
  9. Saikkonen, Pentti & Lütkepohl, Helmut, 1998. "Testing for the cointegrating rank of a VAR process with an intercept," SFB 373 Discussion Papers 1998,51, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
  10. 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.
  11. Willem H. Buiter, 2003. "Overcoming the zero bound on nominal interest rates with negative interest on currency : Gesell's solution," LSE Research Online Documents on Economics 848, London School of Economics and Political Science, LSE Library.
  12. Saikkonen, Pentti & Lütkepohl, Helmut, 2001. "Testing for the cointegrating rank of a VAR process with structural shifts," SFB 373 Discussion Papers 1998,82, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
  13. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  14. Bayoumi, Tamim & Morsink, James, 2000. "A Peek Inside The Black Box: The Monetary Transmission Mechanism In Japan," CEPR Discussion Papers 2435, C.E.P.R. Discussion Papers.
  15. H. Lütkepohl & P. Saikkonen, 1997. "Testing for the Cointegrating Rank of a VAR Process with a Time Trend," SFB 373 Discussion Papers 1997,79, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
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  19. repec:sae:niesru:v:174:y::i:1:p:68-79 is not listed on IDEAS
  20. Miyao, Ryuzo, 2002. "The Effects of Monetary Policy in Japan," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 376-392, May.
  21. Miyao, Ryuzo, 2000. "The Role of Monetary Policy in Japan: A Break in the 1990s?," Journal of the Japanese and International Economies, Elsevier, vol. 14(4), pages 366-384, December.
  22. David Woo, 1999. "In Search of "Capital Crunch"; Supply Factors Behind the Credit Slowdown in Japan," IMF Working Papers 99/3, International Monetary Fund.
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