Does Excess Liquidity Pose a Threat in Japan?

IMF Policy Discussion Papers, April 1, 2005

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Paper examines effects of quantitative easing implemented by the Bank of Japan (BoJ) since early 2001, focusing on impact on inflation expectations and real asset prices.
Suggests possible channels through which quantitative easing may have exerted influence.
Reviews empirical evidence linking open market operations and long-term bond purchases to real yields and other asset prices.
Argues quantitative easing has had smaller effects on nominal and real variables than desired, mainly because the BoJ has not succeeded in credibly communicating its policy intentions once the zero bound on short-term rates ceases to be binding.
Argues that setting clear goals for inflation and a return to interest rate targeting are key elements to avoid deflation, pin down expectations, and avoid instability once deflation wanes.

Quantitative easing may influence inflation expectations and real asset prices through multiple channels (specified qualitatively in the paper).
Empirical literature reviewed links open market operations and long-term bond purchases to:
- real yields
- other asset prices
The observed effects on nominal and real variables have been smaller than policymakers desired in Japan.

Credible communication of policy intentions is crucial, particularly for transitions when the zero bound on short-term rates is no longer binding.
Setting clear goals for inflation is recommended.
Returning to interest rate targeting is recommended as a component of a successful strategy to avoid deflation and to stabilize expectations as deflation wanes.

Authors: Gauti B. Eggertsson, Jonathan David Ostry
Date: April 1, 2005
Series: Policy Discussion Paper No. 2005/005
Issue: 005
Volume: 2005
Pages: 27
DOI: https://doi.org/10.5089/9781451975666.003
Stock No: PPIEA2005005
ISBN: 9781451975666
ISSN: 1564-5193
Subject: Banking, Central banks, Financial institutions, Financial services, Monetary base, Monetary policy, Money, Open market operations, Short term interest rates, Sovereign bonds, Unconventional monetary policies
Keywords: Asia and Pacific, BoJ communications, BoJ policy announcement, BoJ's announcement, BoJ's intention, BoJ's policy, BoJ's purchase, expectations, interest rate, Monetary base, Monetary policy, nominal interest rate, Open market operations, PDP, price level, price level goal, quantitative easing, Short term interest rates, Sovereign bonds, Unconventional monetary policies

IMF Policy Discussion Paper: Does Excess Liquidity Pose a Threat in Japan? By Gauti B. Eggertsson and Jonathan David Ostry, April 1, 2005.