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Optimal monetary policy in a liquidity trap: Evaluations for Japan’s monetary policy

Kohei Hasui & Yuki Teranishi

Journal of the Japanese and International Economies2025https://doi.org/10.1016/j.jjie.2025.101361article
AJG 2ABDC A
Weight
0.37

Abstract

This paper shows (1) a positive analysis demonstrating that recent high inflation rates can be explained by the Bank of Japan (BOJ)’s monetary policy for the COVID-19 pandemic period, “Inflation-Overshooting Commitment,” and (2) a normative analysis showing that the BOJ’s inflation-overshooting commitment aligns with the optimal monetary policy in a liquidity trap within a new Keynesian model with inflation persistence. In detail, we calibrate a hybrid new Keynesian model by Japanese parameters and show optimal monetary policy under commitment. Optimal monetary policy prolongs the zero interest rate until the second quarter of 2024 even after inflation rates overshoot 2 percent. Similarly, the BOJ continues the zero interest rate policy until the second quarter of 2024. The current average inflation rates from 2023Q4 to 2024Q3 reach 2.6 percent and 2.5 percent in the data and the model, respectively. Our conclusion holds for a variety of situations with Japanese parameters, such as a low output gap response to the real interest rate, discounted IS curve, alternative inflation persistences, interest-rate smoothing for the policy rate, an alternative specification of the Phillips curve, inflation target, and low/high anchored inflation expectations and natural interest rates. • Calibrate new Keynesian model with inflation persistence by Japanese parameters. • The BOJ’s monetary policy shares several similarities with optimal monetary policy. • Recent high inflation can be explained by a prolonged zero interest rate policy.

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https://doi.org/https://doi.org/10.1016/j.jjie.2025.101361

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@article{kohei2025,
  title        = {{Optimal monetary policy in a liquidity trap: Evaluations for Japan’s monetary policy}},
  author       = {Kohei Hasui & Yuki Teranishi},
  journal      = {Journal of the Japanese and International Economies},
  year         = {2025},
  doi          = {https://doi.org/https://doi.org/10.1016/j.jjie.2025.101361},
}

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Evidence weight

0.37

Balanced mode · F 0.40 / M 0.15 / V 0.05 / R 0.40

F · citation impact0.16 × 0.4 = 0.06
M · momentum0.53 × 0.15 = 0.08
V · venue signal0.50 × 0.05 = 0.03
R · text relevance †0.50 × 0.4 = 0.20

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