Monetary Policy and the Lost Decade: Lessons from Japan

Abstract

I investigate how monetary policy can avoid a deflationary slump when policy rates are near zero by studying interest rate policy during Japan's "Lost Decade." Estimation results suggest that the Bank of Japan's interest rate policy fits a conventional reaction function with an inflation target near 1%. The disapointing economic performance thus seems primarily due to adverse economic shocks rather than extraordinary policy errors. Also, counterfactual policy simulations suggest that simply raising the inflation target would not have substantially improved performance. However, price-level targeting or combining a higher inflation target with an aggressive output response would have achieved superior stabilization results. Copyright (c) 2010 The Ohio State University. The International Monetary Fund retains copyright and all other rights in the manuscript of this article as submitted for publication..

Growth-Promoting Policies and Macroeconomic Stability

“…A higher inflation rate could be justified, if the size of shocks the economy is facing is expected to be higher in the future or if the neutral real interest rate falls (lowering the nominal interest rate that is consistent with a given inflation target). For Japan, where the zero nominal bound has constrained monetary policy for a long period of time, Krugman (1998) and later Leigh (2009) suggested raising the inflation target to around 4%.…”

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“…A higher inflation rate could be justified if the size of shocks the economy is facing is expected to be higher in the future or if the neutral real interest rate falls (lowering the nominal interest rate that is consistent with a given inflation target). For Japan, where the zero nominal bound has been a significant constraint on monetary policy, Krugman (1998) and later Leigh (2009) suggested raising the inflation target to around 4%.…”

Investigating economic growth, energy consumption and their impact on CO2emissions targets in China

“…One of the reasons is the tendency of the United States's GDP to increase while Japan's GDP slightly increases. Japan's economy has been discussed by Hayashi and Prescott (2002) and Blanchard (2003), as cited in Leigh (2009). They argued that Japan entered a liquidity trap in the mid-1990s and this came to be known as the 'lost decade'.…”