Monetary and Fiscal Policy in a Liquidity Trap: The Japanese Experience 1999-2004

Mitsuru Iwamura, Takeshi Kudo and Tsutomu Watanabe

Discussion papers from Research Institute of Economy, Trade and Industry (RIETI)

Abstract: We characterize monetary and fiscal policy rules to implement optimal responses to a substantial decline in the natural rate of interest, and compare them with policy decisions made by the Japanese central bank and government in 1999-2004. First, we find that the Bank of Japan's policy commitment to continuing monetary easing until some prespecified conditions are satisfied lacks history dependence, a key feature of the optimal monetary policy rule. Second, the term structure of the interest rate gap (the spread between the actual real interest rate and its natural rate counterpart) was not downward sloping, indicating that the Bank of Japan's commitment failed to have suffcient influence on the market's expectations about the future course of monetary policy. Third, we find that the primary surplus in 1999-2002 was higher than predicted by the historical regularity, implying that the Japanese government deviated from the Ricardian rule toward fiscal tightening. These findings suggest that inappropriate conduct of monetary and fiscal policy during this period delayed the timing to escape from the liquidity trap.

Pages: 50 pages
Date: 2005-03
New Economics Papers: this item is included in nep-mac, nep-mon and nep-sea
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Citations: View citations in EconPapers (6)

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