Economic Analysis Series No.162
BOJ's Market Operations and the Call Rate etc.

November, 2000

< Analysis-1 >BOJ's Market Operations and the Call Rate

Kaoru Hosono
(Assistant Professor, Institute of Economic Research, Nagoya City University)
Shigeru Sugihara
(Research Fellow, Economic Research Institute, Economic Planning Agency)
Tsuyoshi Mihara
(Economic Research Institute, Economic Planning Agency)

< Analysis-2 >Monetary Policy in Japan -- Instruments, Transmission Mechanisms, and Effects

Shigeru Sugihara
(Research Fellow, Economic Research Institute, Economic Planning Agency)
Tsuyoshi Mihara
(Economic Research Institute, Economic Planning Agency)
Tomoyuki Takahashi
(Economic Research Institute, Economic Planning Agency)
Mitsusige Takeda
(Economic Research Institute, Economic Planning Agency)

The full text is written in Japanese.

(Summary)

< Analysis-1 >BOJ's Market Operations and the Call Rate

I. Purposes

This paper tries to quantify the effects on call rates of the money market operations by the Bank of Japan. Specifically, it tackles the following questions.

  • i. How much does the supply of reserve affect the overnight call rate?
  • ii. With the overnight call rate zero, is it possible to expand the quantity of reserve?
  • iii. How effective is the target of the call rate set by the Bank of Japan?
  • iv. Are the effects of the supply of reserve different depending on the "excess reserve in the morning", which is interpreted by the market as a signal sent by the Bank of Japan, and on the means of money market operations such as outright purchases of government bonds?
  • v. Are money market operations able to affect not only overnight call rate but also term rates including one week or one month call rates?
II. Method

We estimate demand functions for reserve, which represents the relationship between the call rate and the demand for reserve, thereby investigate the effects of the supply of reserve by the Bank of Japan on call rates.

III. Results
  • i. From August 1994 to December 1999, a 1% increase in the supply of reserve (around 35 billion yen) decreases the overnight call rate by 0.09 basis points.
  • ii. When the period is divided into subperiods, liquidity effects are observed only from November 1997 to February 1999, a period in which Japan experienced financial crisis.
  • iii. The demand for reserve expands greatly only when the overnight rate decreases to less than 0.01%. When the overnight rate is higher than this level, the increase in reserve demand is quite moderate.
  • iv. when we look at the effects of other factors than the supply of reserve on the overnight call rate, we obtained the following findings.
    • a. The target rate set by the Bank of Japan directly affects the overnight rate.
    • b. The "excess reserve in the morning" has influence on the overnight rate only during the financial crisis.
    • c. As for the effects of individual operations on overnight rate, outright purchase of government bonds and Bank of Japan lending have special influences independent of the quantity of reserve. However, other means of operations do not have significant effects.
  • v. As for the effects on term rates including the one week and one month call rates,
    • a. The quantity of reserve does not affect term rates.
    • b. The target rate set by the Bank of Japan exhibits significant influences on term rates.
    • c. The "excess reserve in the morning" had statistically significant influences on the one-week call rate only during the financial crisis.
    • d. As for the effects of individual operations on the one-weak call rate, outright purchase of government bonds and Bank of Japan lending have special influences independent of the quantity of reserve.
    • e. Neither "excess reserve in the morning" nor outright purchase of government bonds affects one month call rate.
IV. Implications
  • i. During the period in which the demand for liquidity is high due to, for example, financial crisis, the Bank of Japan is able to affect the overnight call rate through the supply of reserve.
  • ii. However, in the period other than financial crisis, the supply of reserve has little influence on the overnight call rate. The Bank of Japan affects the overnight call rate only through the target rate. Behind this effectiveness of target rates lies confidence of market participants that the Bank of Japan will provide sufficient reserves to peg call rates to the target rate.
  • iii. Even when the overnight call rate goes to a level near zero, the expansion of the supply of reserve is limited.
  • iv. Daily supply of reserve does not have significant effects on term rates. The target rate affects term rates significantly. It is important to make clear the target rate (or other medium term policy stance) in order to affect term rates.
  • v. Both the "excess reserve in the morning" and outright purchase of government bonds affect only term rates at the short end. They do not affect term rates at the long end.

< Analysis-2 >Monetary Policy in Japan -- Instruments, Transmission Mechanisms, and Effects

This paper analyzes instruments and effectiveness of monetary policy, paying attention to the contrast between interest rate policy, which uses short-term interest rates as instruments, and quantitative policy, which uses quantitative measures such as money supply as instruments.

In chapters 2 and 3, we investigate the validity of the assumption underlying quantitative policy, namely, stability of money multiplier and of money demand function. Chapter 2 is concerned with money multiplier, which relates monetary base and money supply. In Japan, money multiplier was unstable during the 1990s. We decompose the change in money multiplier into changes in the ratios of reserve to deposit, of currency to deposit. The result shows that very low interest rates induced larger currency holdings, which in turn result in significant decline in money multiplier. We further examine balance sheets of economic agents. It is suggested that money creation process through credit to firms and households became unstable, leading to the instability of money multiplier.

Chapter 3 deals with, first, whether long run relationship between money supply and real GDP remained stable during the 1980s. M2+CD, as a whole, is shown to have stable long run relationship with real GDP. However, neither currency nor deposits do not have such stable relationship with real GDP. This means that although M2+CD, as a whole, follows stable long run equilibrium relationship with real GDP, while the composition of M2+CD changes drastically, which results in unstable money multiplier. Next, chapter 3 deals with stability of money demand function by estimating error correction model. Long term interest rates do not affect M2+CD demand, which denies substitution between money and bonds. On the other hand, financial instability after the banking crises of November 1997 greatly affects demand for M2+CD. However, financial instability does not seem to affect demand for currency.

Summing up the results in chapters 2 and 3, neither money multiplier nor money demand is stable so that it seems difficult to stabilize real economy through the control of money supply, as quantitative policy assumes.

Chapter 4 investigates the question whether "liquidity trap" actually occurred in Japan. If it occurred, neither interest rate policy nor quantitative policy is effective. The result using money demand function shows that while currency demand may have been in the realm of infinite increase, demand for M2+CD have not increased without bound. Therefore, both interest rate policy and quantitative policy could have been effective.

Chapters 5 and 6 are concerned with interest rate policy and examine several aspects of transmission mechanism from short-term interest rates to long term interest rates. Chapter 5 estimates the effects of short-term rates on long term rates and forward rates. The result shows that short-term interest rates affect forward rates up to three years, but do not affect longer-term forward rates. This implies that interest rate policy has only a small influence on long-term interest rates. However, if we pick up a period when monetary policy eased more than usually expected, namely spring 1995 with a sharp appreciation of the yen, we find stronger influence on longer forward rates. On the other hand, such a special effect does not show up after the adoption of "zero interest rate policy" in February 1999.

Chapter 6 analyzes the sharp increase in the spreads between corporate bond yields and government bonds yields. Just after the banking crises in November 1997, corporate bond yield spread did not react to the increased default probability. However, after the world wide financial crises of August 1998, default probability began to affect corporate bond yield spread.

Summing up the results in chapters 5 and 6, transmission from short-term interest rates to long-term rates is not smooth. However, stance of monetary authority can enhance the degree to which short-term rates affects long-tern rates.

Chapter 7 constructs structural VAR models in order to investigate the total effects on real economy of monetary policy which uses short term interest rates as policy variables.. Identified monetary policy traditionally adopted by the Bank of Japan seems to have only small effects on output. It accounts only 5% of the variation in real GDP.

Lastly, chapter 8 expounds some recent proposals on monetary policy which purport to be effective through private sector's expectations about the future. This kind of proposal is very promising and it is hoped that further research be made in this direction.

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