Monetary and Fiscal Policy in a Liquidity Trap: The Japanese Experience 1999-2004

51 Pages Posted: 21 Jun 2012 Last revised: 21 Jun 2021

See all articles by Mitsuru Iwamura

Mitsuru Iwamura

Waseda University - Graduate School of Commerce

Takeshi Kudo

Hitotsubashi University - Graduate School of Economics

Tsutomu Watanabe

Hitotsubashi University - Institute of Economic Research

Date Written: February 2005

Abstract

We characterize monetary and fiscal policy rules to implement optimal responses to a substantial decline in the natural rate of interest, and compare them with policy decisions made by the Japanese central bank and government in 1999-2004. First, we find that the Bank of Japan's policy commitment to continuing monetary easing until some prespecified conditions are satisfied lacks history dependence, a key feature of the optimal monetary policy rule. Second, the term structure of the interest rate gap (the spread between the actual real interest rate and its natural rate counterpart) was not downward sloping, indicating that the Bank of Japan's commitment failed to have su.cient influence on the market's expectations about the future course of monetary policy. Third, we find that the primary surplus in 1999-2004 was higher than predicted by the historical regularity, implying that the Japanese government deviated from the Ricardian rule toward fiscal tightening. These findings suggest that inappropriate conduct of monetary and fiscal policy during this period delayed the timing to escape from the liquidity trap.

Suggested Citation

Iwamura, Mitsuru and Kudo, Takeshi and Watanabe, Tsutomu, Monetary and Fiscal Policy in a Liquidity Trap: The Japanese Experience 1999-2004 (February 2005). NBER Working Paper No. w11151, Available at SSRN: https://ssrn.com/abstract=2088724

Mitsuru Iwamura (Contact Author)

Waseda University - Graduate School of Commerce

1-6-1, Nishi-Waseda
Shinjyuku, Tokyo, 169-8050
Japan

Takeshi Kudo

Hitotsubashi University - Graduate School of Economics

Naka 2-1
Kunitachi, Tokyo 186-8601
Japan

Tsutomu Watanabe

Hitotsubashi University - Institute of Economic Research ( email )

2-1 Naka Kunitachi-shi
Tokyo 186-8306
Japan

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