Japan has experienced unprecedented recession and deflation for more than 10 years, while aggressive fiscal policy was conducted under severe budget constraint during the 1990s and the Bank of Japan enforced unprecedented monetary easing, which reduced interbank interest rates to almost zero. However, because these policies were not enough to end deflation, since 2001, the Bank of Japan has implemented quantitative easing. Even now, there is much dispute over whether the quantitative easing has been effective and whether the quantitative easing achieved the current economic recovery. This paper examines the effect of quantitative easing and finds that it has been effective but limited in scope.
JEL Classfication: E52, E58
Keywords: Bank of Japan; Quantitative easing; Monetary policy; Japan
Japan has experienced unprecedented recession and deflation for more than 10 years, while aggressive fiscal policy was conducted under severe budget constraints during the 1990s (except 1995-1997) and the Bank of Japan (BOJ) enforced unprecedented monetary easing, which reduced interbank interest rates to almost zero. However, because these policies were not enough to end deflation, since 2001, the BOJ has implemented quantitative easing. Of course, there is much dispute over whether quantitative easing has been effective and whether the quantitative easing achieved the current economic recovery. Therefore, this paper empirically examines the effect of the quantitative easing.
This paper is structured as follows. Section II explains why the BOJ adopted the quantitative easing policy. Section III discusses the theoretical effects of the policy. Section IV empirically verifies the effect of the quantitative easing. Section V considers how monetary policy should be conducted. Finally, Section VI concludes this paper.
II BACKGROUND OF QUANTITATIVE EASING
In the 1990s, Japan experienced serious economic and financial crises. For example, recorded annual economic growth rates were often negative, and several major financial institutions, such as Hokkaido Takushoku Bank, went into bankruptcy. Japan's premium increased around the middle of 1990s. The financial system was unstable (Ito and Harada, 2002). To overcome these unfavorable economic situations, the BOJ adopted the so-called "zero interest rate policy" from February 1999 to August 2000. Namely, it decided to "flexibly provide ample funds and encourage the uncollateralized overnight call rate to move as low as possible" in February 1999 to avoid a possible intensification of deflationary pressure and to ensure that the economic downtown would come to a halt. Subsequently, in April 1999, BOJ declared its commitment to the zero interest rate until deflationary concerns were dispelled. This policy was intended to affect market expectations regarding the future course of monetary policy actions, thereby stabilizing interest rates (Fujiki and Shiratsuka, 2002).
Introduction of the zero interest rate policy seemed to create an atmosphere of economic recovery. The BOJ stopped the zero interest rate policy. It encouraged the uncollaterized overnight interest call rate to rise on average. However, after the decision, the economy again dropped. The BOJ then tried a more aggressive monetary easing policy. That is, on March 19, 2001, the BOJ decided to increase the outstanding balance of the current accounts at the Bank by one trillion yen to around 5 trillion yen. This is called quantitative easing. In this scheme, the main operating target for money market operations changed from the uncollateralized overnight call rate to the outstanding balance of the current account at the BOJ. The target of the current account balance has been increased several times since then, and the current upper limit level is 30-35 trillion yen.
Under the new procedures, the BOJ provides ample liquidity, and the uncollateralized overnight call rate is determined in the market at a certain low level below the ceiling set by Lombard-type lending facilities. …