The Bank of Japan's Struggle with the Zero Lower Bound on Nominal Interest Rates: Exercises in Expectations Management

This paper reviews and evaluates the Bank of Japan (BOJ)'s monetary policy during the period 1998-2005. In doing so, it pays particular attention to the development of academic thinking on what central banks can do at or near zero interest rates and its relationship with the actual policy measures adopted by the BOJ. The paper argues that the BOJ has done most of the things recommended by academic economists. The most important of these is expectations management as crystallized in the so-called zero interest rate policy. The academic origin of this policy can be found in the seminal work of Krugman. The paper points out, however, that this fact, unfortunately, remained unnoticed by many, and explores reasons behind. The paper then goes on to survey the empirical literature on the effects of the measures adopted by the BOJ. The literature has found that the zero interest rate policy has had significant effects on the term structure of interest rates and supported the economy. Finally, the paper discusses possible reasons for the failure of such measures to stop the deflation of the economy within a short period of time. It points out some difficulties inherent in the expectations management approach and problems created by the impaired financial system.