A Theory of Quantitative Easing Policy and Negative Interest Policy Based on the Japanese Experience

Masayuki Otaki

doi:10.6000/1929-7092.2016.05.20

Abstract

Using a two-period overlapping-generations model, I elucidate how quantitative easing policy and negative interest policy affect an economy based on the Japanese experience under the Abe cabinet. Quantitative easing policy forces a huge amount of money hoarding. Accordingly, the rate of return for money is required to rise. This implies that disinflation and/or deflation are accelerated in Japan, which is in line with reality. On the other hand, quantitative easing policy stimulates the aggregate demand, which brings about a mild recovery in business. The business upturn tightens the foreign market because of an increase in imports and causes the home currency to depreciate.Negative interest policy implies there is a tax levied on money hoarding. Hence, as longas the government expenditure is kept constant, money circulating in an economy decreases, thereby discouraging business. Such a downturn reduces aggregate income and imports. This induces excess supply of foreign exchange. Consequently, the exchange rate appreciates to equilibrate the market.These characteristics of the business cycle in conjunction with changes in the attitude of the monetary authority are entirely consistent with the current Japanese experience under Abenomics.

Highlights

It seems that a great many economists are not aware that there are two methods for controlling widely defined liquidity by a monetary authority in an era of historically low interest
quantitative easing (QE) policy brings about a mild recovery by the multiplier effect, which is theorized by Otaki (2015) in conjunction with a higher rate of return for widely defined liquidity, which implies the acceleration of disinflation and/or deflation
The left-hand side of Equation (10) represents exports of the home economy. ! is the expenditure propensity to the home goods, and eyF is the aggregate income of the foreign country in terms of home currency

Summary

INTRODUCTION

It seems that a great many economists are not aware that there are two methods for controlling widely defined liquidity (roughly speaking, money stock plus short-term public debt) by a monetary authority in an era of historically low interest. Negative reserve interest is the tax levy on hoarding high-powered money To put it more generally, lowering the rate of interest for excess reserves certainly reduces the quantity of widely defined liquidity because such a policy lowers the rate of return for near money assets via arbitrage. QE policy brings about a mild recovery by the multiplier effect, which is theorized by Otaki (2015) in conjunction with a higher rate of return for widely defined liquidity, which implies the acceleration of disinflation and/or deflation. Such a recovery increases imports; and the foreign exchange market falls in excess supply of the home currency.

The Structure of the Model

Individuals

The Dynamics of Money Supply

Market Equilibrium

QE POLICY AND NEGATIVE INTEREST RATE POLICY IN A SMALL OPEN ECONOMY MODEL

CONCLUDING REMARKS