Do the Bank of Japan’s Unconventional Monetary Policies Decrease Real Interest Rates under a Zero Lower Bound?

Yoshito Funashima

doi:10.4236/jss.2018.67010

Abstract

To test Paul Krugman’s pioneering proposal for escaping from liquidity traps, this study examines whether unconventional monetary policies under a zero lower bound decrease real interest rates in Japan. We find a sizable decline in real interest rates under zero interest rate policy and Abenomics monetary policy. In addition, we find no significant decline in real interest rates under other unconventional monetary policies, such as the first quantitative easing and comprehensive monetary easing.

Highlights

Are unconventional monetary policies effective for an economy stuck at the zero lower bound of short-term nominal interest rates? The Bank of Japan (BOJ) was the world’s first central bank to implement several unconventional measures, as shown in Figure 1, in order to tackle a liquidity trap in the latter half of the 1990s
We find a sizable decline in real interest rates under zero interest rate policy and Abenomics monetary policy
We find a sizable decline in real interest rates under the zero interest rate (ZIR) policy and Abenomics monetary policy (QQE)

Summary

Introduction

Are unconventional monetary policies effective for an economy stuck at the zero lower bound of short-term nominal interest rates? The Bank of Japan (BOJ) was the world’s first central bank to implement several unconventional measures, as shown in Figure 1, in order to tackle a liquidity trap in the latter half of the 1990s. Are unconventional monetary policies effective for an economy stuck at the zero lower bound of short-term nominal interest rates? Michaelis and Watzka [6] compare all the unconventional monetary policies (ZIR, QE, and QQE) and confirm a substantial effect on real output and prices only in Abenomics monetary policy (QQE). Krugman [7] developed a pioneering theory of unconventional monetary policy in a liquidity trap, suggesting that a radical regime change of monetary easing can boost an economy through an expected rise in inflation and a decline in real interest rates, even at a zero lower bound. CE, and QQE) and examine whether they decrease real interest rates in Japan under a zero lower bound To this end, we test the validity of the Fisher effect, that is, whether there is high correlation between nominal interest rates and inflation.

Data and Methodology

Empirical Results

Demeaned test in first differences

Three leads and lags

Conclusions