The methodology for assessing interest-rate policy rules: a reply

This note is a brief reply to Watts (2021), who has been critical of the conceptual foundations and methodology in a discussion of the impact of different interest rate policy rules on inflation in Smithin (2020). The reply concludes that the case for a ‘zero real policy rate of interest’ (ZRPR), rather than a ‘zero interest rate policy’ (ZIRP), emerges unscathed.

Monetary Policymaking, 1998–2012

This chapter looks at three case studies of the Bank of Japan's (BOJ) monetary policy to illustrate how these policy ideas influenced BOJ decision making: the decision to implement and then lift the zero interest rate policy (ZIRP) (1998–2000); the first quantitative easing (QE) policy (2001–6); and the policies implemented in response to the global financial crisis and then Japan's “3–11” triple disaster—the massive earthquake, tsunami, and nuclear meltdown that occurred on March 11, 2011. During these fifteen years, the BOJ's worldview made it slow to tackle deflation head-on and cautious in its reflationary measures. The BOJ Policy Board at various times did concede to outside pressure to use unorthodox monetary measures such as forward guidance or QE. It did so reluctantly, however. When afforded room to maneuver, the Policy Board was ready to retreat quickly from monetary easing, in some cases even before the economy was fully out of deflation.

Non-Linear Analysis of the Fisher Effect: In the Case of Japan

The Fisher effect has been commonly analyzed to investigate the long-run relationship between nominal interest rates and expected inflation rate, though it is rarely successful in finding the cointegration relationship as the Fisher effect states. In this paper, a Bayesian Markov switching vector error correction model is applied to analyze non-linearity in the Fisher effect in the case of Japan. We find that the Fisher effect holds in one regime although it does not hold in another regime when the nominal interest rate is stable and does not respond against disequilibrium by the monetary policy such as the zero interest rate policy. This model reveals non-linearity in the error correction mechanism of the Fisher effect in Japan.