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Monetary Policy and the Lost Decade: Lessons from Japan

Author/Editor: Leigh, Daniel
Authorized for Distribution: October 1, 2009
Electronic Access: Free Full Text (PDF file size is 1,050KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: This paper investigates how monetary policy can help ward off a protracted deflationary slump when policy rates are near the zero bound by studying the experience of Japan during the "Lost Decade" which followed the asset-price bubble collapse in the early 1990s. Estimation results based on a structural model suggest that the Bank of Japan's interest-rate policy fits a conventional forward-looking reaction function with an inflation target of about 1 percent. The disappointing economic performance thus seems primarily due to a series of adverse economic shocks rather than an extraordinary policy error. In addition, counterfactual policy simulations based on the estimated structural model suggest that simply raising the inflation target would not have yielded a lasting improvement in performance. However, a price-targeting rule or a policy rule that combined a higher inflation target with a more aggressive response to output would have achieved superior stabilization results.
 
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Series: Working Paper No. 09/232
Subject(s): Deflation | Economic stabilization | Economic models | External shocks | Inflation targeting | Interest rate policy | Monetary policy | Japan
Author's keyword(s): liquidity trap | deflation | monetary policy | Bayesian econometrics
 
English  
    Published:   October 1, 2009        
            Format:   Paper
    Stock No:   WPIEA2009232   Pages:   33
    Price:   US$18.00 (Academic Rate: US$18.00 )
       
     
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