Monetary Policy in the Great Recession

This paper reviews the monetary policy in Japan during the “great recession.” The paper focuses especially on the conduct of monetary policy when the ZIRP (zero interest rate policy) was in place. The nominal call rate was virtually zero, but we find the monetary policy was not that expansionary in some other dimensions. We examine the long-run relation between the real M2+CD and the real GDP, taking into account of a possible shift in the co-integrating relation. The analysis shows there was a long-run relation between the two variables throughout the sample period (1980-2003), although the slope of the co-integrating vector changed around late 1995. Thus, monetary policy did not lose its long-run effectiveness in this sense. The cointegrating relation between M2+CD and the monetary base also seems to have changed around late 1998. In both before and after the regime shift, the long-run relation between M2+CD and the monetary base is positive, suggesting an increase in the monetary base leads to an increase in M2+CD in the long run. Overtime, the relation has become weaker, but the relation continues to be positive, suggesting an increase in the monetary base still leads to an increase in M2+CD. * Earlier versions of this paper were presented at Workshop on Japanese Monetary Issues, March 20 and 22, 2002, at Economic and Social Research Institute, Tokyo, and CESifo Summer Institute Workshop on Economic Stagnation in Japan, July 25-26, 2003, Venice. We thank an anonymous referee, Reuven Glick, Michael Hutchison, Tsutomu Watanabe and other participants of the conferences for comments. ** Department of Economics at University of California, San Diego *** Graduate School of International Relations and Pacific Studies at University of California, San Diego, RIETI, and NBER