The Effect of the Increase in Monetary Base on Japan's Economy at Zero Interest Rates: An Empirical Analysis

Bank of Japan
Source: RePEc


In this paper, we quantify the effect of the so-called "quantitative monetary easing" which the Bank of Japan adopted in March 2001. Now that short-term interest rates are almost zero and monetary base growth is over 20% year on year, active debate continues with respect to the effectiveness of monetary policy at zero interest rates. Taking into account the regime change in monetary policy and the possible non-linearity of money demand at low (or near zero) interest rates, we use a Bayesian vector autoregression (VAR), a VAR with time-varying coefficients, to extract the effect of the increase in the monetary base at zero interest rates. The result of a Bayesian VAR indicates that while an increase in the monetary base previously had a positive impact on prices, it does not now at zero interest rates. In order to investigate the possible reason for this result, we then estimate a money demand function, and test whether a satiation level in demand for the monetary base exists at zero interest rates. The key finding here is that the null hypothesis of the non-existence of the satiation level can be statistically rejected. This means that there may remain room for an increase in the monetary base to stimulate the economy at zero interest rates. Despite the existence of the satiation level of money demand, why does the Bayesian VAR result suggest that an increase in the monetary base does not have a positive impact on economic activity at zero interest rates? One consistent interpretation of these two results is that the effect, if any, of the increase in the monetary base is highly uncertain and very small. We confirm this view by estimating models that include both aggregate demand and aggregate supply functions and testing whether the monetary base enters these equations significantly. Finally, we discuss reasons why the expansion of the monetary base at zero interest rates has such a limited and uncertain effect on the economy.

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Available from: Hiroshi Ugai, Jan 22, 2015
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    • "Therefore, these asset prices rise and yields accordingly decrease. Kimura and Ugai (2003) and Oda and Ueda (2007) show that the effect of the rebalancing portfolio channel is insignificant or too small considering the extensive amount of the CAB expansion and the JGB purchases. "
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    ABSTRACT: The current financial crisis has now led most major central banks to rely on quantitative easing. The unique Japanese experience of quantitative easing is the only experience which enables us to judge this therapy's effectiveness and the timing of the exit strategy. In this paper, we provide a new empirical framework to examine the effectiveness of Japanese monetary policy during the "lost†decade and quantify the effect of quantitative easing on Japan's activity and prices. We combine advantages of Markov-switching VAR methodology with those of factor analysis to establish two major findings. First, we show that the decisive change in regime occurred in two steps: it crept out from late 1995 and established itself durably in February 1999. Second, we show for the first time that quantitative easing was able not only to prevent further recession and deflation but also to provide considerable stimulation to both output and prices. This positive effect is reached through the interest rate factor. These results remain valid even when fiscal policy is simultaneously taken into account in the analysis. If Japanese experience is any guide the quantitative easing policy must be seen as a symptomatic treatment; it must be accompanied with a dramatic restructuring in the financial framework. The exit from quantitative easing must be postponed and decided within a clear program and according to clear numerical objectives.
    Journal of International Financial Markets Institutions and Money 10/2011; 21(4):461-495. DOI:10.1016/j.intfin.2011.01.004 · 0.89 Impact Factor
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    • "The Japanese economy has experienced several distinct periods of macroeconomic activity in recent decades, resulting in many of Japan's macroeconomic variables exhibiting changing behaviors over time. Since Miyao (2000, 2002) analyzed the Japanese economy using a vector autoregressive (VAR) model, the time variation of the relations among Japanese macroeconomic variables has been investigated in several studies (e.g., Fujiwara (2006), Inoue and Okimoto (2008) using a Markov-switching VAR model, and Kimura et al. (2003) using a VAR model with time-varying coefficients). In these studies, the changes in the coefficients in the VAR system are well studied, although the variance of the structural shocks is assumed constant over the sample period or subsample period. "
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    ABSTRACT: This paper analyzes the time-varying parameter vector autoregressive (TVP-VAR) model for the Japanese economy and monetary policy. The parameters are allowed to follow a random walk process and estimated using the Markov chain Monte Carlo method. The empirical result reveals the time-varying structure of the Japanese economy and monetary policy during the period from 1981 to 2008. The marginal likelihoods of the TVP-VAR model and other fixed parameter VAR models are estimated for model comparison. The estimated marginal likelihoods indicate that the TVP-VAR model best fits the Japanese economic data.
    Journal of the Japanese and International Economies 01/2009; 25(3):225-245. DOI:10.1016/j.jjie.2011.07.004 · 0.40 Impact Factor
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    • "4 3 Kimura et al. (2002) "
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    ABSTRACT: We analyze the monetary policy rules which could be implemented in practice under the zero interest rate constraint. Based on the estimated small structural model for Japanese economy, we investigate which policy rule is superior using stochastic simulations. We modify the estimated Taylor-type rule variously by adding a commitment whereby the zero rate policy will be maintained until the inflation rate rises beyond a specific level. We find that such policy rules can be effective if the commitment is set appropriately. We also find that a nonlinear policy rule incorporating preemptive easing can perform well, mostly without any explicit commitment. J. Japanese Int. Economies 22 (1) (2008) 34-67.
    Journal of the Japanese and International Economies 02/2008; 22(1):34-67. DOI:10.1016/j.jjie.2007.03.002 · 0.40 Impact Factor
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