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Do Market Segmentation and Preferred Habitat Theories Hold in Japan? : Quantifying Stock and Flow Effects of Bond Purchases

October 1, 2018
Nao Sudo*1
Masaki Tanaka*2


While major central banks confronting the global financial crisis conducted government bond purchases on an unprecedented scale, macroeconomists began re-examining carefully the once-accepted wisdom that long-term government bond purchases by the central bank reduce long-term yields. This paper follows this shift in economic thought and examines if the wisdom holds in Japan by estimating a dynamic stochastic general equilibrium model that features imperfect substitutability of bonds with different maturities, due to market segmentation and preferred habitats, using Japan's data from the 1980s to 2017. We focus specifically on the transmission mechanism, to determine which matters most: the size of the bond purchases at each period (flow effects), or the total amount of bonds taken away from the private sectors (stock effects). We find that, (i) Japan's data accords well with market segmentation and preferred habitat theories, which implies that government bond purchases conducted by the Bank of Japan have compressed the term premium, exerting an expansionary effect on economic activity and prices; (ii) the effect of bond purchases has been most pronounced since Quantitative and Qualitative Monetary Easing was introduced, compressing the term premium about 50 to 100 basis points as of the end of 2017; and (iii) the compression of the term premium has been mainly driven by stock effects, which underscores the importance of the amount outstanding of the Bank's government bond holdings in determining the term premium.

JEL Classification
C54; E43; E44; E52

Monetary Policy; Term Premium; DSGE Model

The authors are grateful to Hibiki Ichiue, Satoshi Kobayashi, Shun Kobayashi, Takushi Kurozumi, Teppei Nagano, Kenji Nishizaki, Fuminori Niwa, Shigenori Shiratsuka, Reiko Tobe, Jun Uno, Toshinao Yoshiba and seminar participants at the Bank of Japan for helpful comments and discussions. The authors would also like to thank Ichiro Fukunaga, Naoya Kato, and Junko Koeda for providing the data on financial institutions' JGB holdings, Vasco Cúrdia for providing analytical codes, and Azusa Takagi for resourceful research assistance. The views expressed in this paper are those of the authors and do not necessarily reflect the official views of the Bank of Japan.

  1. *1Monetary Affairs Department, Bank of Japan (currently at the Institute for Monetary and Economic Studies)
    E-mail :
  2. *2Monetary Affairs Department, Bank of Japan
    E-mail :


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