Short-run and Long-run Consequences of Unconventional Monetary Policy in Japan

Monetary policy is a powerful policy tool in stabilizing short-term economic fluctuations. However, no matter how effective it is, it could have unintended adverse impacts on the economy if the central bank continued extreme monetary easing over a long period of time. Japan is an exceptional country where such concern exists. This paper analyzes the effects of unconventional monetary policy in Japan since the end of the 1990s. We explore the effects not only on stabilizing short-term macroeconomic fluctuations such as the GDP gap, but also on medium- and long-term productivity such as total factor productivity (TFP). If the prolonged ultra-low interest rate environment distorts the price mechanism and causes misallocation of funds, the unconventional monetary policy could reduce the productivity of the economy. The estimation results show that the Bank of Japan (BOJ)'s unconventional monetary policy had a significant positive impact on the GDP gap even under a liquidity trap where the policy rate hit its effective lower bound (ELB). However, they also show that unconventional monetary policy had a significant negative impact on TFP growth. The results suggest that while unconventional monetary policy was effective in boosting the economy in the short term, the prolonged ultra-low interest rate environment may have had a negative impact on medium- and long-term productivity growth in the Japanese economy.