Monetary and Fiscal Policy in a Liquidity Trap

Edited by Mitsuru Iwamura, Takeshi Kudo and Tsutomu Watanabe

in Monetary Policy with Very Low Inflation in the Pacific Rim

Published by University of Chicago Press

Published in print October 2006 | ISBN: 9780226378978
Published online February 2013 | e-ISBN: 9780226379012 | DOI:
Monetary and Fiscal Policy in a Liquidity Trap

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This chapter employs both theoretical and empirical tools to examine Japanese macroeconomic stabilization over the past five years. The role of fiscal policy in a liquidity trap is reviewed. It is shown that market participants expected that the Bank of Japan (BOJ) would not adopt expansionary monetary policy sufficient to offset an expected decline in the natural rate of interest. The Japanese government has been diverging from Ricardian fiscal policy since the latter half of the 1990s. The optimal commitment solution can be enforced through history-dependent inflation targeting in which the target inflation rate is revised depending on the past performance of monetary policy. The commitment of BOJ failed to have a sufficient impact on the market's expectations about the future course of monetary policy. Moreover, it is noted that the primary surplus in 1999–2002 was higher than predicted by the historical regularity.

Keywords: fiscal policy; liquidity trap; macroeconomic stabilization; Bank of Japan; monetary policy; Japanese government; inflation rate; market

Chapter.  16027 words.  Illustrated.

Subjects: Business and Management

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