Working Paper: NBER ID: w10878
Authors: Takatoshi Ito; Frederic S. Mishkin
Abstract: This paper reviews Japanese monetary policy over the last two decades with an emphasis on the experience of deflation from the mid-1990s. The paper is quite critical of the conduct of monetary policy, particularly from 1998 to 2003. The Bank of Japan's rhetoric was not helpful in fighting deflation, and the interest rate hike in August 2000 amid deflation was a serious mistake. Deflation can be quite costly, and a key element in both preventing and escaping deflation is the management of expectations, using either price level or inflation targeting, because the zero lower bound on interest rates means that the overnight interest rate can no longer be used as the instrument of monetary policy. This paper proposes how to best manage expectations to exit deflation. Price-level targeting overcomes theoretical problems, such as need for a history dependent strategy, associated with inflation targeting. However, because actions speak louder than words, management of expectations also involves non-conventional monetary policies, a combination of which might have to be tried to help the Japanese economy escape its deflationary trap.
Keywords: Japanese monetary policy; deflation; price level targeting; inflation targeting; quantitative easing
JEL Codes: E42; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Bank of Japan's monetary policy from 1998 to 2003 (E52) | worsening deflationary conditions (E31) |
| interest rate hike in August 2000 (E49) | deepening deflationary spiral (E31) |
| failure to manage expectations effectively (D84) | decreased aggregate demand (E20) |
| managing expectations through price level targeting (E31) | potentially reverse deflation (E31) |
| lack of effective communication and commitment to inflation targeting (E61) | weakened public confidence (H12) |
| weakened public confidence (H12) | exacerbated deflationary pressures (E31) |
| prolonged deflation (E31) | economic deterioration (F44) |
| deflation (E31) | increased unemployment (J65) |
| deflation (E31) | financial instability (F65) |