The Empirical Analysis Of The Liquidity Trap And The Effectiveness Of Monetary Policy In Japan

The world economy is deteriorated by the subprime crisis.The U.S., E.U.,and Japan lowered the interest rates repeatedly and provided liquidity for the financial markets aiming to prevent recession,therefore,stepped into zero interest rate age.When the zero lower bound on the central bank's instrument rate is strictly binding,what else expansionary monetary policy the central bank could implement,and how effective of it.The status quo seems similar to Japan after the financial crisis in 1997 when the bank of Japan lowered the interest rate to the zero bound continuously, which raised drastic debate on whether Japan had fallen into the liquidity trap.Adopting empirical analysis,this paper will try to study whether it was effective the zero rate and quantitative easing policies on economic recovery including stimulating inflation and growth of GDP.Paul Krugman began to concern about the problem of liquidity trap which once only appeared in the Macroeconomics textbook as per the long economic slump in Japan and developed a theoretical model of Krugman liquidity trap.From then on,western economists(including Japanese scholars) did a lot of research on whether Japan had fallen into the trap. However,conclusions of their studies differed by various empirical methods.On the counter part,Chinese economists seldom applied quantitative methods.Furthermore,they deemed that the monetary policy was invalid by the normative analysis while Japanese economists could not get an agreed conclusion based on empirical analysis.Hence,it is worth studying the problems of liquidity trap and the effectiveness of monetary policy in Japan.The paper is arranged as follows:in Chapter 1,money demand and monetary policy effectiveness theories will be reviewed;in Chapter 2, quantitative analysis will be applied to study whether Japan was troubled by liquidity trap;we will find out what measures Bank of Japan can implement in Chapter 3;in the last Chapter,we will do empirical analysis on the effectiveness of zero rate and quantitative easing polices.The innovation of this paper is mainly in quantitative methods.The demand for cash was trapped by Keynes liquidity trap,and the demand for M2+CDs fell into Krugman liquidity trap.Moreover,Bank of Japan's monetary policy was effective by the VAR model.And the quantitative easing policy can work through both the money channel and the credit channel,but money channel was more effective than credit channel. However,the interest channel was of no effect.The conclusion of this paper is that it's a good way for the central bank to make the reserve balance as the manipulate target to implement expansionary policy in order to stimulate inflation and economic growth when the economy is trapped by zero bound and deflation spiral.It's a complete proof that Bank of Japan's zero rate and quantitative easing policies helped Japan out of recession.