Efficiency of Quantitative Easing in Japan during (2001,2006) through Estimation of Precautionary Money Demand

Abstract

This paper investigates the effect of "quantitative easing monetary policy (QEMP)" which the Bank of Japan (BOJ) adopted from March 2001 through June 2006, by changing operating target for money market from interest rate to the monetary base that is defined as the sum of "Cash" and "Reserves at the BOJ". The paper confirms that the monetary policy has contributed to the recovery of the prolonged deflation. First we estimate vector autoregressive (VAR) model, which consists of the reserves, stock, exchange rate and real GDP. Next we decompose money stock into transaction money and precautionary money to evaluate the transmission mechanism of the effect of reserves on the real economy by taking into account the financial anxiety. We have found a quantitative easing shock firstly increase transaction money and then raise output and price, which dispel the anxiety. We also confirm that a liquidity trap did not exist during the period of quantitative easing monetary policy.