Bank of Japan

Abstract: What should a central bank do when faced with a weak aggregate demand even after reducing the short-term nominal interest rate to zero? To address this question, we solve a central bank's intertemporal loss minimization problem, in which the non-negativity constraint on nominal interest rates is explicitly considered. We find that the optimal path is characterized by policy inertia, in the sense that a zero interest rate policy should be continued for a while even after the natural rate of interest returns to a positive level. By making such a commitment, the central bank is able to achieve higher expected inflation, lower long-term nominal interest rates, and a weaker domestic currency in the adverse periods when the natural rate of interest significantly deviates from a steady-state level.

Abstract: This paper analyzes the time-varying parameter vector autoregressive (TVP–VAR) model for the Japanese economy and monetary policy. The parameters are allowed to follow a random walk process and estimated using the Markov chain Monte Carlo method. The empirical result reveals the time-varying structure of the Japanese economy and monetary policy during the period from 1981 to 2008. The marginal likelihoods of the TVP–VAR model and other fixed parameter VAR models are estimated for model comparison. The estimated marginal likelihoods indicate that the TVP–VAR model best fits the Japanese economic data.

Abstract: We analyse the spillover of the turmoil in money markets in the second half of 2007 to FX swap and long-term cross-currency basis swap markets. We find that the use of swap markets to overcome US dollar funding shortages by non-US financial institutions resulted in marked deviations from covered interest parity conditions and the impairment of liquidity in these markets.