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Natural Rate of Interest in Japan -- Measuring its size and identifying drivers based on a DSGE model --

Author

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  • Yosuke Okazaki

    (Bank of Japan)

  • Nao Sudo

    (Bank of Japan)

Abstract

In this paper, we explore the level and determinants of the natural rate of interest in Japan. To this end, we construct a DSGE model that is specifically designed to address potential drivers of the natural rate that are considered important in previous studies, and estimate the model using Japan's data from 1980 to 2017. Our findings are summarized in the following three points. First, the natural rate has shown a secular decline over time, from 400 basis points in the 1980s, to 30 basis points in the last five years. The decline has been mostly attributed to changes in neutral technology. Changes in investment-specific technology, working-age population, and demand factors have also contributed to the decline, but the quantitative impacts have been small. Second, a secular decline and the quantitative importance of neutral technology are also seen when considering the expected future natural rates over a long horizon, indicating that changes in the natural rate have been perceived as persistent rather than temporal changes over the course of history. Third, in the banking crisis starting in the 1990s, financial factors stood out as an important driver that depressed the natural rate. Their contribution holds second place, after changes in neutral technology, when comparing potential drivers by the size of their contribution to variations in the natural rate. Our results suggest the need to monitor the financial intermediation function, as well as the path of neutral technology when analyzing developments in the natural rate.

Suggested Citation

  • Yosuke Okazaki & Nao Sudo, 2018. "Natural Rate of Interest in Japan -- Measuring its size and identifying drivers based on a DSGE model --," Bank of Japan Working Paper Series 18-E-6, Bank of Japan.
    • Handle: RePEc:boj:bojwps:wp18e06
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    1. Taylor, Alan M. & Davis, Josh & Fuenzalida, Cristian, 2019. "The Natural Rate Puzzle: Global Macro Trends and the Market-Implied r," CEPR Discussion Papers 14201, C.E.P.R. Discussion Papers.
    2. Nao Sudo & Masaki Tanaka, 2021. "Quantifying Stock and Flow Effects of QE," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(7), pages 1719-1755, October.
    3. Ryuichiro Hashimoto & Nao Sudo, 2022. "Transmission of Flood Damage to the Real Economy and Financial Intermediation: Simulation Analysis using a DSGE Model," Bank of Japan Working Paper Series 22-E-5, Bank of Japan.
    4. Nao Sudo & Masaki Tanaka, 2018. "Do Market Segmentation and Preferred Habitat Theories Hold in Japan? : Quantifying Stock and Flow Effects of Bond Purchases," Bank of Japan Working Paper Series 18-E-16, Bank of Japan.
    5. Hongjin Li & Naifang Su, 2020. "Financial Factors, Openness and the Natural Interest Rate in China," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 28(4), pages 76-100, July.
    6. Lee, Dong Jin & Hahm, Joon-Ho & Park, Hail & Park, Ki Young, 2020. "Measuring the Natural Rate of Interest with Financial Gaps: The Cases of Japan and South Korea," Japan and the World Economy, Elsevier, vol. 54(C).
    7. Mr. Fei Han, 2019. "Demographics and the Natural Rate of Interest in Japan," IMF Working Papers 2019/031, International Monetary Fund.

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    More about this item

    Keywords

    Natural Rate of Interest; Monetary Policy Implementation; DSGE Model;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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