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On the role of monetary policy in a deflationary economy: The case of Japan

Author

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  • Motoshige Itoh

    (Faculty of Economics, University of Tokyo)

  • Naoki Shimoi

    (CIRJE, Faculty of Economics, University of Tokyo)

Abstract

In this paper we review the role of monetary policy for a country facing deflationary pressure based on the recent experience of the Japanese economy. We discuss economic background of inflation policy in Japan and analyze the impacts of the policy. Japanese economy is in a liquidity trap now. Two types of reasons were pointed out to be in liquidity traps. They are a real factor and a monetary factor. The former factor is the case analyzed by Krugman, where IS curve shifts due to structural reason such as aging of population. Under this condition a negative real interest rate is requested to escape from the liquidity trap. However, liquidity trap can also arise from monetary reason and the scenario of escape from the trap is different. We illustrate the case where deflationary expectation leads the economy to a liquidity trap. If it is necessary to utilize monetary policy for generating inflation expectation, we then need some explicit monetary policy rules, which is strong enough to escape from liquidity traps but at the same time which is effective to suppress unnecessary political pressure and to keep the independence of the central bank. Inflation targeting is a candidate for such a rule.

Suggested Citation

  • Motoshige Itoh & Naoki Shimoi, 2000. "On the role of monetary policy in a deflationary economy: The case of Japan," CIRJE F-Series CIRJE-F-90, CIRJE, Faculty of Economics, University of Tokyo.
    • Handle: RePEc:tky:fseres:2000cf90
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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2000/2000cf90.pdf
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    References listed on IDEAS

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    1. Buiter, Willem H. & Panigirtzoglou, Nikolaos, 1999. "Liquidity Traps: How to Avoid Them and How to Escape Them," CEPR Discussion Papers 2203, C.E.P.R. Discussion Papers.
    2. Okina, Kunio, 1999. "Monetary Policy under Zero Inflation: A Response to Criticisms and Questions Regarding Monetary Policy," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 17(3), pages 157-182, December.
    3. Fischer, Stanley, 1982. "Seigniorage and the Case for a National Money," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 295-313, April.
    4. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
    5. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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    1. Itoh, Motoshige & Shimoi, Naoki, 2000. "On the Role of Monetary Policy in a Deflationary Economy: The Case of Japan," Journal of the Japanese and International Economies, Elsevier, vol. 14(4), pages 238-260, December.
    2. Buiter, Willem, 2003. "Deflation: Prevention and Cure," CEPR Discussion Papers 3869, C.E.P.R. Discussion Papers.
    3. Tibor Tatay & Zsanett Orlovits & Zsuzsanna Novák, 2022. "Inhomogeneous Financial Markets in a Low Interest Rate Environment—A Cluster Analysis of Eurozone Economies," Risks, MDPI, vol. 10(10), pages 1-22, October.
    4. Oda, Nobuyuki & Okina, Kunio, 2001. "Further Monetary Easing Policies under the Non-negativity Constraints of Nominal Interest Rates: Summary of the Discussion Based on Japan's Experience," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 323-360, February.

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