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Effects of the Quantitative Easing Policy:
A Survey of Empirical Analyses

July 2006
Hiroshi Ugai*1

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Executive Summary

This paper surveys the empirical analyses that examine the effects of the Bank of Japan (BOJ)'s quantitative easing policy (QEP), which was implemented for five years from March 2001 through March 2006. While the stock of empirical analyses on the effects of the QEP has yet to accumulate sufficiently, this paper aims at comprehensively summarizing the literature that is presently available (as of June 2006) which verifies the effects of the QEP on Japan's economy.

The QEP consisted of three pillars: (i) shifting the BOJ's main operating target from the uncollateralized overnight call rate to the current account balances (CABs) at the Bank, and supplying ample liquidity in an amount substantially in excess of the required reserves; (ii) being committed to maintain the policy until the CPI registers stably zero percent or an increase year-on-year (hereafter referred to as " the commitment"); and (iii) increasing the purchase of long-term JGBs if deemed necessary to facilitate meeting the targeted CABs. Under the QEP, the uncollateralized overnight call rate, formerly the main operating target, declined to zero percent. However, a zero interest rate is not an effect exclusive to the QEP, but could also be realized under the traditional interest rate regime. So in order to verify the effects of the QEP, the effects derived from a current interest rates of zero percent and those not captured by the current zero interest rates should be differentiated clearly. For the latter, the quantity and expectations effects must be identified clearly, and the extent of each properly assessed.

This paper first summarizes the empirical analyses on the effects of the QEP according to transmission channels, and then proceeds to summarize the QEP's macroeconomic effects on Japan's economy.

First, this paper takes up the transmission mechanism of the effects of the QEP. After classifying the QEP's effects into three types according to operating measures, that is, "effect of the commitment to maintain the QEP on the expected future path of short-term interest rates," "effects of expanding the size of the BOJ's balance sheet by increasing CABs," and "effects of altering the composition of the BOJ's balance sheet by increasing the purchases of long-term JGBs," this paper examines the empirical analyses specifically to find to what extent and through which transmission channel each effect was realized. The results are summarized as follows.

The effect of the commitment that lowered future short-term interest rates worked through a mechanism whereby the expectation of the zero interest rate being maintained for some time into the future affected various expectations for interest rates with longer terms and the yields of other financial assets in financial markets. Empirical analyses clearly confirm this effect in lowering the yield curve, centering on the short to medium term (the policy duration effect).

The effects from expanding the size of the BOJ's balance sheet (expansion of the monetary base) by increasing the CABs can be divided into (i) the portfolio rebalancing effect, which affects the premium portion of the yields of financial assets that are imperfect substitutes for the monetary base; and (ii) the signaling effect, which affects the private sector's expectations for the future path of short-term interest rates. The empirical analyses present mixed results for the former as to whether there was such an effect or not, and even among those that detect such an effect, many generally conclude that the magnitude of this effect was smaller than that from the commitment. With respect to the latter, at least the effect of bolstering expectations that the monetary easing would continue into the future was detected during certain phases.

To consider the effects from altering the composition of the BOJ's balance sheet by increasing purchases of long-term JGBs, this paper divides these effects into the portfolio rebalancing effect and the signaling effect for expectations regarding the future path of short-term interest rates. The results are mixed for the former, as is the case for the effect from an increase in CABs. With respect to the latter, the effect of bolstering expectations that monetary easing would continue into the future was not detected, and, in one phase, inflation premiums temporarily increased.

As far as previous empirical analyses are concerned, the largest easing effect from the QEP was through the channel of influencing the expected future path of short-term interest rates. From this result, it is suggested that when a central bank conducts monetary policy with the zero interest rate bound in mind, information dissemination concerning monetary policy from the central bank to the private sector is critical to manifest the policy effects.

Bearing these points in mind, the paper then proceeds to take up studies that empirically analyze the QEP's overall macroeconomic impact on Japan's economy through various transmission channels. In general, many of these analyses view that the QEP created an accommodative environment and thus supported the recovery of the corporate sector.

Looking at the contents of the macroeconomic impact, while the transmission channels are not specified, these macroeconomic analyses verify that because of the QEP, the premiums on market funds raised by financial institutions carrying substantial non-performing loans (NPLs) shrank to the extent that they no longer reflected credit rating differentials. This observation implies that the QEP was effective in maintaining financial system stability and an accommodative monetary environment by removing financial institutions' funding uncertainties, and by averting further deterioration of economic and price developments resulting from corporations' uncertainty about future funding.

Granted the positive above effects of preventing further deterioration of the economy reviewed above, many of the macroeconomic analyses conclude that the QEP's effects in raising aggregate demand and prices were limited. In particular, when verified empirically taking into account the fact that the monetary policy regime changed under the zero bound constraint of interest rates, the effects from increasing the monetary base were not detected or smaller, if anything, than during periods when there was no zero bound constraint. The studies generally show that the QEP had a greater monetary easing effect than that stemming from merely lowering the uncollateralized overnight call rate to zero percent, while the effects in raising aggregate demand and prices nevertheless turned out to be limited. Many of these analyses present analytical results and interpretations indicating that in addition to the zero bound constraint of the interest rate, the substantial decline in responsiveness to monetary easing on the part of corporations and financial institutions resulting from their deteriorated core capital due to a plunge in asset prices played a major roles.

The author would like to thank Mr. Kosuke Aoki, London School of Economics, and many Bank of Japan colleagues including Messrs. Kunio Okina, Hideo Hayakawa, Shigenori Shiratsuka, Nobuyuki Oda, Takeshi Kimura, Koichiro Kamada, Naohiko Baba, Ippei Fujiwara, and Tomohiro Sugo for their valuable comments. All remaining errors are the author's responsibility. The views expressed in this paper are solely the responsibility of the author and should not be interpreted as reflecting the official views of the Bank of Japan.

  • *1 Monetary Affairs Department, Bank of Japan


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