International Finance Discussion Papers

<p>This paper examines Japan's experience in the first half of the 1990s to shed some light on several issues that arise as inflation declines toward zero. Is it possible to recognize when an economy is moving into a phase of sustained deflation? How quickly should monetary policy respond to sharp declines in inflation? Are there factors that inhibit the monetary transmission mechanism as interest rates approach zero? What is the role for fiscal policy in warding off a deflationary episode? We conclude that Japan's sustained deflationary slump was very much unanticipated by Japanese policymakers and observers alike and that this was a key factor in the authorities' failure to provide sufficient stimulus to maintain growth and positive inflation. Once inflation turned negative and short-term interest rates approached the zero-lower-bound it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations we draw the general lesson from Japan's experience that when inflation and interest rates have fallen close to zero and the risk of deflation is high stimulus both monetary and fiscal should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.</p><p>This work has been selected by scholars as being culturally important and is part of the knowledge base of civilization as we know it. This work was reproduced from the original artifact and remains as true to the original work as possible. Therefore you will see the original copyright references library stamps (as most of these works have been housed in our most important libraries around the world) and other notations in the work.</p><p>This work is in the public domain in the United States of America and possibly other nations. Within the United States you may freely copy and distribute this work as no entity (individual or corporate) has a copyright on the body of the work.</p><p>As a reproduction of a historical artifact this work may contain missing or blurred pages poor pictures errant marks etc. Scholars believe and we concur that this work is important enough to be preserved reproduced and made generally available to the public. We appreciate your support of the preservation process and thank you for being an important part of keeping this knowledge alive and relevant.</p>