effect imposing a horizontal lm curve? in order to do so, it would, in general, have to respond to rightward shifts in the is curve by adding reserves and facilitating faster money growth, so as to prevent interest rates from rising. this might be appropriate very early in an expansion, when the unemployment rate is high and inflation is declining, but it is not, in my judgment, prudent in the mature stage of an expansion, and it is most surely imprudent once utilization rates have increased toward or beyond their capacity levels. the alternative is to maintain an upward sloping lm curve. in the static model, this is the case when the money supply is fixed ; allowing for trend growth and inflation, it would be equivalent to holding money growth constant, assuming a stable money demand function. in this case, a shift in the is curve would raise interest rates as the is curve moved along the upward sloping lm curve. this is an example of monetary policy “ leaning against the wind. ” the resulting pro - cyclical movement in interest rates increases the stability of the economy in much the same way as cyclical swings in the federal budget deficit. some might argue, however, that even if short - term interest rates do not rise, long - term interest rates, equity prices, and the dollar may change in ways that damp the cyclical swing in demand and thereby lessen the necessity of a direct response of monetary policy. this is sometimes referred to as the “ gyroscope ” theory ( the bond market is the economy ’ s gyroscope ) and the active part of management of the cycle is in the hands of so - called “ bond market vigilantes, ” some of whom are undoubtedly in the audience this afternoon. when long - term rates rise in response to a cyclical strengthening, it reflects, in large part, the expectation of higher short - term interest rates. specifically, it reflects expectations about monetary policy. while monetary policy cannot be a slave to the bond market, when the cyclical state of the economy suggests the desirability of a pro - cyclical response in interest rates, the federal reserve should pat the bond market on the back and appreciate its help, but not expect the bond market to carry the entire burden. monetary policy in this case needs to validate the movement in the bond market, rather than resist it. if it does not, surely real long - term interest rates and the dollar will decrease, eroding

hiroshi nakaso : the potential impact of large - scale monetary accommodation remarks by mr hiroshi nakaso, deputy governor of the bank of japan, at the paris europlace financial forum, tokyo, 25 november 2014. * * * introduction it is a great honor to have this opportunity to speak today before the paris europlace financial forum. in my remarks, after touching on the latest action taken by the bank of japan to expand quantitative and qualitative monetary easing, dubbed the qqe, i would like to share my views on the potential impact of large - scale monetary accommodation on the functioning of financial markets, with a special focus on japan. monetary policy in major economies let me begin with our monetary policy. in april last year, the bank of japan introduced the qqe to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. the main objectives of the qqe have been to dispel a view that took root among people over a long period of deflation that prices would not rise – in other words, a deflationary mindset – and to create a situation in which households and firms behave on the assumption that prices would moderately increase. specifically, in terms of the policy transmission mechanism, we intend to raise inflation expectations through a strong and clear commitment to achieve the price stability target of 2 percent, and at the same time to exert downward pressure across the entire yield curve through massive purchases of government bonds. as a result, real interest rates will decline, thereby stimulating such private demand components as business fixed investment, private consumption, and housing investment. the upward pressure on prices will grow stronger as demand increases and the output gap narrows accordingly. rises in actual inflation rates will be translated into higher expected rates of inflation and thus lower real interest rates. this will reinforce the virtuous cycle as the economy is provided with additional stimulus. since its inception, the qqe has been producing the intended effects, and japan ’ s economy has steadily followed a path towards the achievement of the price stability target of 2 percent. in fact, the year - on - year rate of change in the consumer price index ( cpi ) excluding fresh food, which stood at minus 0. 5 percent in march 2013 immediately before introducing the qqe, subsequently turned positive and moved up to reach above 1 percent by the end of last year. in recent months, however, a couple of developments on the price front have