• Liquidity Trap and Optimal Monetary Policy: Evaluations for U.S. Monetary Policy
  Kohei HasuiTomohiro SugoYuki Teranishi

  Abstract

  This paper shows that the Fed’s exit strategy works as optimal monetary policy in a liquidity trap. We use the conventional new Keynesian model including a recent inflation persistence and confirm several similarities between optimal monetary policy and the Fed’s monetary policy. The zero interest rate policy continues even after inflation rates are sufficiently accelerated over the 2 percent target and hit a peak. Under optimal monetary policy, the zero interest rate policy continues until the second quarter of 2022 and the Fed terminates it one quarter earlier. Eventually, inflation rates exceed the target rate for over three years until the latest quarter. The policy rates continue to overshoot the long-run level to suppress high inflation rates. Furthermore, high inflation rates under optimal monetary policy can explain about 70 percent of the inflation data for 2021 and 2022 years. However, these are still lower than the inflation data. This is because optimal monetary policy raises the policy rates faster than the Fed does. The remaining 30 percent of inflation rates can be constrained by the Fed’s more aggressive monetary policy tightening after the zero interest rate policy.

   

  Introduction

  
  The theory of monetary policy has been developed since the 1990s based on a new Keynesian model as represented by Clarida et al. (1999) and Woodford (2003). Woodford (2003) finds history dependence as a general property of optimal monetary policy with commitment in a purely forward-looking new Keynesian model. He shows that the forward-looking economy and history dependence are two sides of a coin in optimal monetary policy. Eggertsson and Woodford (2003b,a), Jung et al. (2001, 2005), and Adam and Billi (2006) extend optimal monetary policy analysis with commitment to an economy in a liquidity trap and show that a robust conclusion about a feature of optimal monetary policy is history dependence. The consequence of optimal monetary policy under commitment in a liquidity trap is predicted by these papers. However, such predictions have not been evaluated in the past two decades. Now, we show the answer.

   

  WP051

   

   

  2024.07

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• Optimal Monetary Policy in a Liquidity Trap: Evaluations for Japan’s Monetary Policy
  Kohei HasuiYuki Teranishi

  Abstract

  This paper shows that the Bank of Japan’s monetary policy shares several common points with optimal monetary policy in a liquidity trap to large negative shocks by the recent pandemic. The zero interest rate policy continues even after inflation rates sufficiently exceed the 2 percent and hit the peak. Optimal monetary policy keeps the zero interest rate policy until the second quarter of 2024 and the Bank of Japan continues the zero interest rate at least until the second quarter of 2024. Recent high inflation rates can be explained by a prolonged zero interest rate policy. Average inflation rates from 2021 to 2023 years are 2.2 percent and 2.1 percent in the data and the simulation, respectively. According to scenarios for anchored inflation expectations and long-run natural interest rates, the optimal timing to terminate the zero interest rate policy and a speed of the monetary tightening after the zero interest rate policy change. As anchored inflation expectations and natural interest rates decline, the zero interest rate policy continues longer.

   

  Introduction

  
  In Japan, the Bank of Japan (BOJ) virtually introduces the zero interest rate policy from September 1995 by cutting the policy rate to about 0.5 percent. During the zero interest rate policy, a policy commitment, recently so called as the forward-guidance policy, is a key for monetary policy. For example, the BOJ Governor, Masaru Hayami, announces at a press conference in April 1999 that the BOJ continues the zero interest rate policy until the deflationary concerns are dispelled to lower long-term interest rates. This is the first case of the commitment policy in a liquidity trap. Moreover, in September 2016, the BOJ introduces the inflation-overshooting commitment. Under this policy, the BOJ commits to continue the monetary easing until the year-on-year CPI inflation rate stably exceeds the 2 percent target rate. This commitment policy works as optimal monetary policy to increase an inflation rate and its expectation and to lower the real interest rate as discussed below. Now, the BOJ faces an exit policy from a liquidity trap under the commitment and we would like to evaluate whether the BOJ conducts optimal monetary policy.

   

  WP050

   

   

  2024.07

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• The Bank of Japan’s Stock Holdings and Long-term Returns
  Hibiki Ichiue

  Abstract

  The Bank of Japan (BoJ) purchased equity index exchange-traded funds (ETFs), including Nikkei 225 ETFs, for over a decade and has not sold any ETFs it purchased. On March 31, 2021, the BoJ’s ETF holdings were more than 10% of the free float of the First Section of the Tokyo Stock Exchange. Primarily because the Nikkei index is price-weighted, the BoJ’s indirect holdings as a percentage of the market capitalization vary widely among individual stocks. To identify the effects of the uneven demand shocks, this paper runs instrumental-variable cross-sectional regressions of cumulative returns between September 30, 2010, a few days before the first announcement of ETF purchases, and March 31, 2021, when the BoJ terminated Nikkei 225 ETF purchases. The results suggest that the price multiplier is around 6 to 9; a 1 percentage point higher BoJ share in a stock’s market capitalization is associated with a roughly 6 to 9 percentage point higher return. The estimated multiplier is much higher than a typical estimate of 1 based on U.S. data. There is no evidence of a return reversal in the 9 months after Nikkei 225 ETF purchases ended. Various analyses, including monthly return regressions, support the analysis of cumulative returns and provide additional insights.  

   

  Introduction

  Many empirical studies find that demand for stocks influences stock prices. The literature often estimates the price multiplier, the percent change in the price of a particular stock when investors purchase 1% of the market capitalization of that stock. Gabaix and Koijen’s (2022) survey suggests that a typical estimate of the price multiplier is about 1.１ On the other hand, finance theory indicates that the impact of demand shocks on asset prices depends on the nature of demand. For instance, if demand shocks are expected to be more persistent, the impact is larger since asset prices reflect not only current but also expected demand. To contribute to this literature and the literature on unconventional monetary policy, this paper explores a unique natural experiment, the Bank of Japan’s (BoJ’s) persistent holdings of equity index exchange-traded funds (ETFs).  

   

  WP049

  2024.04

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