The Recent Monetary Policy and Money Demand in Japan

After the burst of the bubble, the Japanese economy has experienced a hard recession which Japan has never experienced after the war. The Japanese government conducted the huge public investment without success. The Bank of Japan also performed the low interest policy to boost the economy. However, Japanese economy got worse after 1997 when the leading financial institutions suddenly collapsed. The Japanese economy had plunged into the deflationary spiral. The BOJ took the so-called zero interest policy after 1999 to fight against the deflationary pressure. Furthermore, it started the qualitative easing policy by increasing the outright purchase of government bond after March 2001. The policy stands on the idea that money stock has the positive effect on the economy. The money demand has to be stable for the policy to succeed. The bank of Japan (2003) recently reported that the long-run equilibrium relationship between money stock and real economic activity can no longer be detected, though such relationship could be found before 1997. In this paper we quantify that money stock has a positive relationship with real economic activity, and money demand is still stable. We found one cointegration in the cointegration test between money stock, real GDP, and share price in the period from 1981 through 1997. However the cointegration has broken out when the sample period was extended beyond 1997, as the BOJ (2003) suggests. We performed the cointegration test again by comprising a new variable: financial anxiety and found one cointegration. Dynamic money demand function was estimated with an error correction term. The result was almost statistically satisfactory, suggesting the stability of money demand.