## Monetary Policy and the Lost Decade: Lessons from Japan

_IMF Working Papers, October 1, 2009_

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## Bibliographic details
- Authors: Daniel Leigh
- Published: October 1, 2009
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451873795.001

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### Summary and central finding
- The 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.

### Model, estimation, and interpretation
- Approach: estimation results are based on a structural model (details within the paper).
- Policy rule characterization: the Bank of Japan's interest-rate policy is well described by a conventional forward-looking reaction function.
- Implied inflation objective: about 1 percent.

### Counterfactual policy simulations and scenarios
- Raising the inflation target alone:
  - 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.
- Alternative rules that perform better:
  - A price-targeting rule would have achieved superior stabilization results.
  - A policy rule that combined a higher inflation target with a more aggressive response to output would have achieved superior stabilization results.

### Policy implications and recommendations
- A static increase in the inflation target is unlikely to be sufficient to counteract the effects of prolonged adverse shocks when policy rates are near the zero bound.
- More effective strategies include:
  - Implementing a price-targeting rule.
  - Combining a higher inflation target with a more aggressive response to output in the policy rule.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/monetary-policy-and-the-lost-decade-lessons-from-japan-23365_