Monetary policy in Japan's 'Great Recession:' neo-Wicksellian and monetarist approaches

This thesis examines the problems posed by Japans recent macroeconomic experience for conventional monetary policy theory and practice. Japans experience with deflation and the zero lower bound for nominal official interest rates is placed in the context of neo-Wicksellian and monetarist interpretations of the monetary policy transmission mechanism. The neo-Wicksellian approach to the zero bound problem is shown to suffer significant limitations in view of Japans experience, while a monetarist interpretation of the transmission mechanism is shown to be more robust. The thesis considers the role of the official interest rate and the money base in vector autoregression models of the Japanese economy, finding that the economy became less amenable to effective stabilisation by monetary policy from the early 1990s onwards. A new approach to estimating a neo-Wicksellian monetary policy rule for the Bank of Japan is proposed and the robustness of the parameters of this rule determined. The thesis motivates a role for the money base in the determination of real output and inflation. A policy rule in the growth rate of the nominal money base is estimated and the stability of its parameters with respect to a hypothesised structural break and changes in the governorship of the Bank of Japan is considered. Aggregate demand and supply specifications for the Japanese economy are estimated that show a distinct role for the money base that is independent of the official interest rate. These specifications are extended to develop a model of the Japanese economy. The model is distinctive in incorporating both neo-Wicksellian and monetarist views of the monetary policy transmission mechanism. The macroeconomic stabilisation properties of various interest rate and money base growth rules are compared in the context of the model, using stochastic simulation methods. In particular, a policy rule in the growth rate of the nominal money base with the nominal official interest rate set to zero is simulated and shown to have macroeconomic stabilisation properties that compare favourably to conventional interest rate rules. The thesis concludes that the neglect of money in contemporary monetary policy theory and practice is mistaken in view of Japans recent macroeconomic experience