ERI Discussion Paper Series No.52
Monetary Policy and the Real Economy

March 1991
Hiroshi Yoshikawa
(Tokyo University, Economic Planning Agency)


This paper analyzes two issues concerning monetary policy in Japan: (1) How monetary policy has been conducted in postwar Japan, and (2) How monetary policy affects the real economy.

At present, there is considerable disagreement among economists on the role of money in economic fluctuations. On the one hand, monetarists (Friedman [1968], Lucas [1972, 1977]) take unanticipated changes in the money supply exogenously caused by central banks as the major impulse of economic fluctuations. On the other hand, real business cycle theory argues that macroeconomic fluctuations are set off by technological shocks such as changes in total factor productivity, and that the propagation of these shocks through the economy is due to non-monetary factors such as optimal consumption smoothing by individuals and large in the construction of new capital. According to this theory, therefore, money does not play a major role either as a shock or as a propagation mechanism: money is nothing but a veil (King and Plosser [1984], Plosser [1990]). Between these two polar views, Keynesians hold that both real demand and monetary shocks are important in business cycles.

To make real progress in this controversy, it is essential for us to understand precisely how monetary policy is conducted. Irrespective of views expressed, however, most macroeconomic analyses both theoretical and empirical, assume either an exogenous money supply or very simple feedback rules of monetary policy. These simplifying assumptions make calculations of equilibrium consistent with rational expectations feasible, but it is rarely questioned whether the assumptions made are a good approximation of how monetary policy is actually conducted in the real world.

This paper attempts to shed light on this problem by analyzing monetary policy in both seasonal (section 1) and business cycle fluctuations (section 2). We argue that at business cycle frequencies, time-varying nominal interest rate smoothing is a good approximation of monetary policy in Japan and that there is no rigid feedback rule. Section 3 analyzes the transmission mechanism of monetary policy. We study the experiences of Japan over a thirty-year period, and compare them with those of the U.S. Not surprisingly, we find that the transmission mechanism of monetary policy substantially differs over times and also across countries. Section 4 offers concluding remarks.

Structure of the whole text

  1. full text別ウィンドウで開きます。(PDF-Format 117 KB)
  2. page2
    1. Money Supply and the Seasonal Cycle
  3. page11
    2. Money Supply and the Business Cycle
  4. page24
    3. The Transmission of Monetary Policy
  5. page27
    4. Concluding Remarks
  6. page31
    Figure and Table
    1. [1]別ウィンドウで開きます。(PDF-Format 889 KB) [2]別ウィンドウで開きます。(PDF-Format 859 KB) [3]別ウィンドウで開きます。(PDF-Format 476 KB)
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