MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/FEBRUARY 2001

Introduction
Kunio Okina, Hiroo Taguchi, andShigenori Shiratsuka
The theme of the Ninth International Conference organized by the Institutefor Monetary and Economic Studies of the Bank of Japan was “The Role ofMonetary Policy Under Low Inflation: Deflationary Shocks and Policy Responses,”
and the conference was held on July 3 and 4, 2000.
The purpose of this conference was to discuss the role that monetary policy canand should play when there are deflationary shocks, such as the collapse of an asset
price bubble occurring in an environment of low inflation, the experience in Japan in
the 1990s being a case in point. When inflation rates are low and nominal interest
rates become close to zero, there are limits to the effectiveness of monetary policy
through ordinary interest rate channels. While monetary policy will very likely
depend heavily on expectation formation, how expectation will be formed in suchcircumstances is not very certain, since there are hardly any examples of such a situation in modern economic history that we can learn from, with the exception of theGreat Depression in the United States in the 1930s and the economic stagnation in
Japan in the 1990s. However, there is no guarantee that these cases will remain
remote outliers in the future, since most industrial economies have now opted for,and are achieving, low inflation.
The organizers of this conference felt that it would be valuable to bring together
the wisdom of both theoretical and empirical analysts, as well as policy makers, andask them to focus on this challenging topic. Throughout the conference every effort
was made to draw implications for the conduct of monetary policy in practice.
The conference began with an opening speech by Masaru Hayami (Governor,
Bank of Japan), followed by keynote speeches from Allan H. Meltzer (Carnegie
Mellon University) and John B. Taylor (Stanford University), both of whom arehonorary advisors to the Institute for Monetary and Economic Studies. The following four sessions dealt with more specific aspects, featuring two papers each.
The conference concluded with a panel that attempted to summarize the entire
discussion.
Governor Hayami’s opening speech touched upon the lessons of the bubble
period and from the monetary policy of the 1980s, and suggested the need for central
banks to aim at price stability that supports medium- to long-term sustainablegrowth, not price stability at a particular point in time.
In his keynote speech (“Monetary Transmission at Low Inflation: Some Clues
from Japan in the 1990s”), Allan H. Meltzer emphasized that the fundamental causeof Japan’s prolonged stagnation was that the yen had appreciated in spite of therelative decline in productivity in Japan compared to the United States, and stressedthat an adaptive policy rule for the growth of monetary base would have mitigated1the problems that Japan had faced, especially in 1997–98. John B. Taylor also
reviewed the experience of Japan in the 1990s in his speech (“Low Inflation,
Deflation, and Policies for Future Price Stability”), and emphasized the need forcentral banks to have an inflation target, even if the target is implicit or statedindirectly. While he thought the zero interest rate policy adopted in Japan is acontingency plan and is a form of monetary policy rule, he argued that the Bank ofJapan should be transparent about what will come after the zero interest rate policy.
Session 1 was titled “An Overview of Monetary Policy under Asset Price
Fluctuation and Deflation.” The paper by Naruki Mori, Shigenori Shiratsuka, andHiroo Taguchi (“Policy Responses to the Post-Bubble Adjustments in Japan: A
Tentative Review”) analyzed financial and economic developments and the responsesof both monetary and prudential policies in Japan after the bursting of the asset pricebubble in the 1990s. The authors’ main conclusion was that the timing and extent ofeasing was adequate if assessed as a response to an ordinary recession, but with thebenefit of hindsight it is possible to argue that a more aggressive easing may havebeen needed to cope with the negative impacts of the bursting of the bubble. The
second paper, presented by Thomas F. Cargill (“Monetary Policy, Deflation, andEconomic History: Lessons for the Bank of Japan”) also reviewed the developmentof the Japanese economy in the 1990s and compared it with historical experiences,primarily the U.S. Great Depression in the 1930s, but also those of Sweden andJapan during the same decade. As a lesson from these episodes, he concluded
that concern with its independence made the Bank of Japan, similar to theFederal Reserve in the 1930s, reluctant to take the needed aggressive measures, andrecommended inflation targeting as a future strategy.
Many structural factors influence the transmission mechanism and effectivenessof monetary policy. From among them, Session 2, on “Transmission Mechanismand Structural Rigidities,” took up the issues of stability of the financial system andemployment adjustment. Marvin Goodfriend (“Financial Stability, Deflation, andMonetary Policy”) argued that a central bank could be “fooled by its own credibility”
for low inflation into being insufficiently preemptive in a business expansion, andthen constrained by the zero bound from reducing the real interest rate sufficiently inthe subsequent recession. He examined how this chain of events, leading to deflationand stagnation, could be weakened or broken by a quantitative monetary policy andcarry tax on the currency, and argued that another option, fiscal policy, is relatively
ineffective at best and counterproductive at worst. The paper by Hiroshi Fujiki,
Sachiko Kuroda Nakada, and Toshiaki Tachibanaki (“Structural Issues in theJapanese Labor Market: An Era of Variety, Equity, and Efficiency or an Era of
Bipolarization?”) illustrated recent structural changes in the Japanese labor market,
with particular focus on “peripheral workers,” e.g. women, youths, and older
workers. They thought that careful assessment of these structural changes isimportant in the proper formation of monetary policy.
Session 3, “Expectation Formation and Monetary Policy,” started with a theoretical
paper by Lars P. Hansen and Thomas J. Sargent (“Acknowledging Misspecification in
Macroeconomic Theory”). Their paper took up the issue of the misspecification ofmodels upon which policy decision is to be based. Their analysis indicated that for

2 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/FEBRUARY 2001

Introduction

robust policy control under uncertainty, policy makers must act more aggressively thanin a standard case. The second paper, by Makoto Saito and Shigenori Shiratsuka(“Financial Crises as the Failure of Arbitrage: Implications for Monetary Policy”)
interpreted the widening of the discrepancy observed in 1997–98 in offshore
money markets between rates offered to Japanese banks and foreign banks as evidenceof a malfunctioning of market arbitrage. The authors argued that the central banks’intervention in such a crisis is effective in resuming the function of the markets.
Session 4 was designed to shed light on “The Implications of Low Inflation andInterest Rates for the Conduct of Monetary Policy.” The first paper, by Lars E. O.
Svensson (“The Zero Bound in an Open Economy: A Foolproof Way of Escaping
from a Liquidity Trap”), proposed a combination of price-level targeting, a currency
devaluation, and a temporary exchange rate peg as a foolproof way of “jump-starting”
an economy facing a deflationary spiral and a zero bound on nominal interest
rates. Nobuyuki Oda and Kunio Okina (“Further Monetary Easing Policy under
Non-Negativity Constraints of Nominal Interest Rates: Summary of Discussion
Based on Japan’s Experience”) reviewed the background to and workings of the zerointerest rate policy, and discussed the feasibility and effectiveness of various policy
recommendations raised on Japan. They also examined the desirability of inflation
targeting under zero interest rates and concluded that, given the social and politicalenvironment, it could undermine the flexibility of monetary policy.
It was the intention of the conference organizers to promote a general discussion
on the role of monetary policy under low inflation. However, it was only natural thatthe discussions tended to concentrate on current monetary policy in the Japanese
economy. Again naturally, no conclusion was reached on many issues, partly due tothe differing degrees of understanding among the participants of Japanese economic
conditions, but mainly due to the multifaceted nature of the problem. Nonetheless,the organizers felt that a consensus was reached among the participants about
the importance of addressing these issues, and that the conference succeeded incontributing to this end.
Although the theme of the conference was relatively clearly specified, thespectrum of issues and discussion that were brought forward was much broader thanwe expected. Below is our summary of the main points.
(1) Deflation can be even harder to deal with than inflation. Therefore, it isimportant to attempt to achieve price stability by preventing inflationary as
well as deflationary risks in a preemptive manner. This was one of the few
points on which most of the participants agreed.
(2) Several recommendations were made for economies that are at the zero
lower bound on nominal interest rates and are experiencing a deflationary
shock: (1) enhancing the announcement effect of a zero interest-rate policy;(2) devaluing the domestic currency; (3) purchasing a large amount oflong-term government bonds; (4) setting a target for the inflation rate or
the price level; (5) imposing negative interest rates by the introduction of acash-carrying tax; and (6) some combination of the above proposals. Views
differed on each of the proposals, both in the assessment of their applicability
in general and to the present Japanese economy in particular. The cause of3

this difference rested partly on how to evaluate the effectiveness of suchmeasures, but mostly on how to weigh the possible positive impacts against
the possible negative side effects. However, there was to some extent a
common awareness of the need to provide an “anchored expansion” framework in order to avoid monetary expansion going too far and the economy
becoming uncontrollable.
(3) There was a broad consensus in favor of a “constrained discretion” in inflation
targeting, which may contribute to improving the transparency of monetary
policy management and dealing flexibly with short-term shocks. However,there was disagreement about the desirability of adopting inflation targetingin Japan in the present economic, social, and political environment.
(4) With regard to policy rules, opinions were divided as to whether monetary
policy should react aggressively or conservatively to changes in observed
information variables under uncertainty.
(5) It was suggested that Japan’s monetary policy responses after the bursting of
the bubble were broadly adequate for dealing with a normal business contraction, but that the degree of monetary easing might have been insufficient tooffset the impact of the bursting of the bubble, whose magnitude wasunprecedented. However, it was also recognized that there were limits to whatmonetary policy alone could do without a fundamental cure for problems in
the financial system.
(6) With regard to lessons from the history, there were differences on how toassess fiscal policy under Finance Minster Korekiyo Takahashi during the
1930s (the “Takahashi Fiscal Policy”) in Japan. While some argued that it was
effective enough to overcome deflation, others pointed out that this policy
should be evaluated in connection with the social and economic environment
and from a longer-term perspective, since it might not have worked without
the cross-border capital movement regulation that existed then; it had also
triggered a growing burden of government debt that became evident later on.
(7) Most participants agreed that financial system stability is essential for achieving long-run price stability. There was, however, division among the participants on the role of monetary policy under financial instability: some took
the view that the role of monetary policy should be limited to soothing
the financial markets by supplying ample liquidity at lower interest rates;
others argued that monetary policy should deal more actively with themalfunctioning of financial markets when markets are segmented andarbitrage between them fails due to a tightened liquidity constraint onmarket participants.
(8) The importance of broadening unemployment statistics to include “discouraged workers” was proposed as a way of capturing more comprehensively the
structural changes in Japanese labor markets, particularly changes in the
supply of women, youths, and older workers. It was recognized, however, that
there were still issues to be addressed concerning how to use information
based on such statistics for the conduct of monetary policy.

4 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/FEBRUARY 2001

Introduction

LIST OF ROUND-TABLE PARTICIPANTS
Jack H. Beebe
Senior Vice President and Director of
Research, Economic Research
Department, Federal Reserve Bank of
San FranciscoMårten Blix
Head of Division for International
Macro Analysis, Economics
Department, Sveriges Riksbank
J. Alfred Broaddus, Jr.
President, Federal Reserve Bank ofRichmond
Thomas F. Cargill
Professor of Economics, Departmentof Economics, University of Nevada,
RenoCharles Collyns
Senior Advisor, Asia and Pacific
Department, International Monetary
Fund
Christine M. Cumming
Executive Vice President and Directorof Research, Federal Reserve Bank of
New York
Francisco G. Dakila, Jr.
Acting Bank Officer VI, Departmentof Economic Research, Bangko Sentral
ng Pilipinas
Spencer Dale
Head, Monetary Assessment andStrategy Division, Bank of England
Hiroshi FujikiManager and Senior Economist,
Research Division 1, Institute for
Monetary and Economic Studies, andMoney and Capital Markets Division,
Financial Markets Department, Bankof JapanShin-ichi Fukuda
Associate Professor, Faculty of
Economics, University of Tokyo
Vítor Gaspar
Director General of Research,
European Central Bank
Marvin Goodfriend
Senior Vice President and Policy
Advisor, Economic Research
Department, Federal Reserve Bankof Richmond
Craig S. Hakkio
Senior Vice President and Director of
Research, Federal Reserve Bank ofKansas City
Jane T. Haltmaier
Senior Economist, Division ofInternational Finance, Board ofGovernors of the Federal Reserve
SystemLars P. Hansen
Homer J. Livingston DistinguishedService Professor of Economics,
Department of Economics,
The University of Chicago
Masaru Hayami
Governor, Bank of Japan
Fumio Hayashi
Professor, Faculty of Economics,
University of Tokyo
Jean Hilgers
Member of the Board of Directors,
Banque Nationale de Belgique, S.A.
Takamasa Hisada
Chief Manager, Research Division 1,
Institute for Monetary and Economic
Studies, Bank of Japan5

Achjar Iljas
Deputy Governor in Charge ofMonetary Policy and Statistics,
Bank Indonesia

Sachiko K. Nakada
Research Division 1, Institute for
Monetary and Economic Studies,Bank of Japan

Keimei Kaizuka
Professor, Faculty of Law, Chuo
University

Tim Chung-Ko Ng
Manager, Forecasting, Economics
Department, Reserve Bank of
New Zealand

Grant Kirkpatrick
Head, Japan Desk, Organisation for
Economic Co-operation andDevelopment
Donald L. Kohn
Director, Division of Monetary Affairs,
Board of Governors of the Federal
Reserve System
Ling Tao
Deputy Director, Research
Department, The People’s
Bank of China
Tiff Macklem
Chief, Research Department,
Bank of Canada
Allan H. Meltzer
The Allan H. Meltzer University
Professor of Political Economy,
Graduate School of Industrial
Administration, Carnegie Mellon
University

Nobuyuki Oda
Manager and Senior Economist,
Research Division 1, Institute for
Monetary and Economic Studies, andMoney and Capital Markets Division,
Financial Markets Department,
Bank of Japan
Kunio Okina
Director, Institute for Monetary andEconomic Studies, Bank of Japan
Fabio Panetta
Assistant Manager, Research
Department, Banca d’Italia
Christian Pfister
Deputy Director, Monetary
Research and Statistics Division,
Banque de France
Hermann Remsperger
Member of the Board, Deutsche
Bundesbank

Guy M. Meredith
Executive Director, Research
Department, and Director, Hong
Kong Institute of Monetary Research,
Hong Kong Monetary Authority

Georg Rich
Director, Deputy Head of
Department 1, Head of Economic
Division, Schweizerische National
Bank

Naruki Mori
Assistant Manager and Economist,
Research Division 1, Institute for
Monetary and Economic Studies,Bank of Japan

John C. Robertson
Senior Economist and Policy Advisor,
Research Department, Federal Reserve
Bank of Atlanta

6 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/FEBRUARY 2001

Introduction

Makoto Saito
Associate Professor, Faculty of
Economics, Osaka University
Masaaki Shirakawa
Advisor to the Governor, Policy
Planning Office, Bank of Japan
Shigenori Shiratsuka
Manager and Senior Economist,
Research Division 1, Institute for
Monetary and Economic Studies,Bank of Japan

John B. Taylor
Mary and Robert Raymond Professorof Economics, Department of
Economics, Stanford University
Leslie E. Teo
Lead Economist, Economics
Department, Monetary Authorityof Singapore
Oreste Tristani
Economist, Economic and Financial
Research Unit, European Central Bank

Glenn Stevens
Assistant Governor, Reserve Bank ofAustralia

Kazuo Ueda
Member of the Policy Board,
Bank of Japan

Lars E. O. Svensson
Professor, Institute for International
Economic Studies, Stockholm
University

Atchana Waiquamdee
Senior Director, Monetary PolicyGroup, Bank of Thailand

Job Swank
Departmental Director, Monetaryand Economic Policy Department,
De Nederlandsche Bank N.V.
Toshiaki Tachibanaki
Professor, Kyoto Institute of Economic
Research, Kyoto University
Hiroo Taguchi
Associate Director, Institute for
Monetary and Economic Studies,Bank of Japan

William R. White
Economic Adviser, Head of Monetaryand Economic Department, Bank forInternational Settlements
Yutaka Yamaguchi
Deputy Governor, Bank of Japan
Chin-Bang Yoo
Chief Economist and Assistant
Director, Economic Studies Office,
The Bank of Korea

78 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/FEBRUARY 2001

Keynote Speeches

Chairman/Moderator
Kunio Okina (Bank ofJapan)

SessionOpening Speech

Hiroshi Fujiki (Bank of Japan),
Sachiko K. Nakada (Bank of Japan),Toshiaki Tachibanaki (Kyoto University)

Concluding Panel: The
Role of Monetary Policy
under Low Inflation

13:00–17:30 4 The Implications of
Low Inflation andInterest Rates for the
Conduct of Monetary
PolicyKunio Okina

Kazuo Ueda (Bank ofJapan)

Spencer Dale (Bank of England),Jack H. Beebe (Federal Reserve Bank of
San Francisco)Nobuyuki Oda (Bank of Japan),
Kunio Okina
Vítor Gaspar (European Central Bank),
Donald L. Kohn (Board of Governorsof the Federal Reserve System),
Yutaka Yamaguchi (Bank of Japan),
Allan H. Meltzer,
John B. Taylor

Glenn Stevens (Reserve Bank ofAustralia),
Job Swank (De Nederlandsche Bank N.V.)

Lars E. O. Svensson (Stockholm
University)

Christine M. Cumming (Federal Reserve
Bank of New York),
Tim Chung-Ko Ng (Reserve Bank of New
Zealand)

Fumio Hayashi (University of Tokyo),
Tiff Macklem (Bank of Canada)

Jane T. Haltmaier (Board of Governors of
the Federal Reserve System),
Grant Kirkpatrick (Organisation for
Economic Co-operation and Development)

William R. White (Bank for International
Settlement),
Kazuo Ueda ( Bank of Japan)Mårten Blix (Sveriges Riksbank),
Shin-ichi Fukuda (University of Tokyo)

Thomas F. Cargill (University of
Nevada, Reno)
Jean Hilgers (Banque Marvin Goodfriend (Federal Reserve
Nationale de Belgique, Bank of Richmond)
S.A.)

Georg Rich (Schweizerische National
Bank),Charles Collyns (International Monetary
Fund)

Hiroo Taguchi (Bank of Japan),
Shigenori Shiratsuka (Bank of Japan),
Naruki Mori (Bank of Japan)—

Allan H. Meltzer (Carnegie Mellon
University),
John B. Taylor (Stanford University)

Designated Discussant—Paper Presenter/Panelist
Masaru Hayami (Bank of Japan)

3 Expectation Formation J. Alfred Broaddus, Jr. Lars P. Hansen (The University ofand Monetary Policy(Federal Reserve
Chicago)Bank of Richmond)
Makoto Saito (Osaka University),
Shigenori Shiratsuka

2 Transmission
Mechanism andStructural Rigidities

1 An Overview of
Masaaki Shirakawa
Monetary Policy under (Bank of Japan)
Asset Price Fluctuation
and Deflation
13:00–17:30

9:00–11:45

Tuesday, 9:00–11:45
July 4

Monday,July 3Date/Time

PROGRAM