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Monetary Policy Responses to
Bubbles in Japan and the US
David E. Weinstein
Columbia University
Consultant FRBNY
NBER
1
Quick Overview
• Data and History
– What Happened?
– Comparing the Policy Response in the US and Japan
• Understanding Monetary Policy in a Deflationary
Environment
2
1999/02
1999/05
1999/08
1999/11
2000/02
2000/05
2000/08
2000/11
2001/02
2001/05
2001/08
2001/11
2002/02
2002/05
2002/08
2002/11
2003/02
2003/05
2003/08
2003/11
2004/02
2004/05
2004/08
2004/11
2005/02
2005/05
2005/08
2005/11
2006/02
2006/05
2006/08
2006/11
2007/02
2007/05
2007/08
2007/11
2008/02
2008/05
2008/08
2008/11
2009/02
Axis Title
Both Japan and the US have Suffered Similar
Declines in Equity Prices
Relative Movements in Nikkei 225 in dollars and S&P 500
1.6
1.4
1.2
1
0.8
Nikkei in Dollars
0.6
S&P
0.4
0.2
0
3
How Does Current Crisis Compare with
Japanese Crisis?
• Japanese Stock Market Peaked in December of 1989
• US Market Peaked in October of 2007
– One can define that month as “Month 0” in both countries to do
comparisons
4
The Decline in the S&P was Greater than that
of the Nikkei
Relative Movements in Nikkei 225 in dollars and S&P 500
(12/89 =1 for Japan 10/07 =1 for US)
1.20
1.00
0.80
0.60
Nikkei
S&P
0.40
0.20
0.00
-70
-65
-60
-55
-50
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
5
10
15
Months Relative to Peak
5
In Japan Stocks Fell Before Housing, but in
the US Housing Prices Fell First
Movements in Housing Price Indexes
(Peak Year = 1)
1.10
1.00
0.90
0.80
0.70
Case-Shiller 10 City Index
OFHEO
0.60
Japan Commercial Real Estate
Japan Residential Real Estate
0.50
0.40
0.30
0.20
-10 -9
-8
-7
-6
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14 15
Years Relative to Stock Market Peak
The fact that housing continued to rise for years after stocks began their decline
may have reduced the sense of urgency in Japan
6
Growth and Inflation Slumped in Japan
7
Policy Timeline
• Feb 12, 1999: Introduction of Zero Interest Rate Policy
(ZIRP)
• April 13, 1999: Governor announced commitment to
maintain ZIRP until deflationary concerns dispelled
• August 11, 2000: Termination of ZIRP: call rate target
raised to 25 basis points
• March 19, 2001: Introduction of Quantitative Easing (QE)
policy
– Includes commitment to maintain QE (and hence ZIRP) until
deflation over
– Specific quantitative criterion: until y-o-y increase in core CPI
positive in a stable manner
8
Some Basic Ideas about Monetary Policy in a
Deflationary Environment
• The ISLM model is a bad way to think about policy
because it assumes prices are fixed
• If prices are falling, the real interest rate will be above the
nominal rate
– Consumers have an incentive to delay purchases until prices fall
• If interest rates are zero, bonds and cash become perfect
substitutes
– Economic agents will be indifferent between holding additional
government bonds (paying an interest rate of zero) and cash (also
paying an interest rate of zero)
– As a result, additional expansions in the money supply (e.g.
quantitative easing) ceases to be effective
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Monetary Policy 1990-2008
10
Source: Woodford
Inflation Rates were Comparable but Declined
More Rapidly in the US
Inflation in Japan and the US
3.5
3.0
2.5
Axis Title
2.0
Japanese Core Inflation
1.5
US Core Inflation
1.0
0.5
0.0
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
35
40
45
50
55
60
Months Relative to Stock Market Peak
11
Fed Cut Interest Rates Much More Rapidly
than BOJ
Interest Rates in Japan and the US
9
8
7
6
5
Japanese Call Rate
Federal Funds Rate
4
3
2
1
0
-45 -42 -39 -36 -33 -30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0
3
6
9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60
Months Relative to Stock Market Peak
12
As a Result Real Interest Rates fell Much
More Sharply in the US
Real Interest Rates in Japan and the US
7.0
6.0
5.0
4.0
3.0
Japanese Real Int.
US Real Int.
2.0
1.0
0.0
-45 -40 -35 -30 -25 -20 -15 -10
-5
0
5
10
15
20
25
30
35
40
45
50
55
60
-1.0
-2.0
Months Relative to Peak
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What Can be Done if we enter deflation?
• Government must try to alter inflationary expectations
– If agents expect inflation and interest rates are zero, they will have
an incentive to spend
• How to do this?
– Inflation Target or Price Level Target
• Problem is commitment but “Open Mouth Operations” can help
– Devalue Currency
• Raises Import prices and generates inflation
– Fiscal Policy
• Higher deficits are likely to force a central bank to monetize some of
the debt and generate a higher inflation rate
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Were Explicit commitments effective in changing
expected future path of interest rates? (Woodford)
• BOJ (Okina and Shiratsuka) argues that Gov. Hayami's
announcement in April 1999 did further lower implied
forward rates
– However, BOJ gave many signals that it was eager to abandon
ZIRP
• In fact, BOJ abandoned ZIRP as soon as real growth
appeared, despite continuing deflation
• Term structure data suggest imminent tightening expected
even before the abandonment, but definite shift upward in
implied forward rates around this time
• Recovery aborted soon after: due to signaling effect of
abandonment of ZIRP?
15
Conclusions
• US situation today bears striking similarity to Japan’s
situation in 1989
– Declines in equity and housing markets were, if anything, larger
than in Japan
• US policy response looks very different
– Much faster interest rate cuts by Fed
– US has negative real interest rates – Japan never did
– Much faster rate of bank bailouts and fiscal policy
• Will this be enough?
– Major test of modern economic theory
– Other policy options remain
16