The Taylor Rule in Japan

Kensuke Miyazawa

Japanese Economy, 2011, vol. 38, issue 2, 79-104

Abstract: The purpose of this article is to reexamine Japan's financial policies from the perspective of the Taylor rule, which has become the standard for assessing financial policies. The Taylor rule is a rule for setting the bank rate, whereby the nominal bank rate is expressed as a linear function of the inflation rate and gross domestic product (GDP) gap. In microeconomic analyses in recent years, the Taylor rule has been increasingly used for setting financial policies, and efforts are being promoted to analyze the rule itself. In this article, I start by presenting the results of an empirical analysis of the Taylor rule in Japan. When analyzing bank rates vis-à-vis the Taylor rule, the reaction factor of the bank rate to the inflation rate and GDP gap are important. Most empirical analyses show slight differences in the values, but indicate that the values fall within parameters that are largely consistent with the theory. Next, I performed a supplementary examination of these empirical analyses after changing various parameters. Nonetheless, in many cases, I achieved results similar to those produced by previous studies, suggesting that the results of those studies are stable. Finally, I assess the bank rate by comparing the Taylor rule and the actual call rate. The results show that even though the parameter values focused on in the empirical analyses are confirmed, there are several problems to be addressed when it comes to thinking about actual financial policies. Specifically, what indicator reflects the real equilibrium interest rate? What are the prices of goods that the central bank must take into consideration? And what is the potential GDP that is taken into consideration when calculating the GDP gap?

Date: 2011
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DOI: 10.2753/JES1097-203X380204

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