Effects of the Loss and Correction of a Reference Rate on Japan's Economy and Financial System: Analysis Using the Financial Macro-econometric Model

Hiroshi Kawata, Tomiyuki Kitamura, Koji Nakamura, Yuki Teranishi and Saiki Tsuchiya
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Hiroshi Kawata: Bank of Japan
Tomiyuki Kitamura: Bank of Japan
Koji Nakamura: Bank of Japan
Saiki Tsuchiya: Bank of Japan

No 12-E-11, Bank of Japan Working Paper Series from Bank of Japan

Abstract: This paper analyzes the effects on the financial system and the real economy of errors in a reference rate, and the subsequent rapid corrections of the rate. In this analysis, we use the Financial Macro-econometric Model, which reflects an adverse feedback loop between the financial system and the real economy. The main results are as follows. First, fluctuations of financial and economic activity may increase significantly when there is no correct and reliable reference rate and individual financial institutions extend loans based on different market rate indicators. Second, the transmission mechanism of monetary policy may weaken in the absence of a reference rate. And third, when errors are found in a reference rate, the subsequent upward corrections at a rapid pace may affect the real economy to a notable extent. The effects of the corrections can grow especially if such corrections occur at the time of a financial crisis. These results suggest that a correct and reliable reference rate is important for maintaining stability in the macroeconomy.

Date: 2012-12-14
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