The Harm of Cumulative Issue of Long–term Government Bonds and Open Market Operations, 1991:11–1997:3

Abstract

This paper aims to clarify the coordination between the fiscal and monetary policy authorities as well as the features of open market operations by the monetary policy authority in the government’s issuing of more bonds. At first, to investigate the climate of the secondary market and the movement of the central bank, I have come up with the following three cases; (1) the case in which there is no effect of the government bonds,(2) the case in which the monetary authority has priority in coping with a temporal increase of the interest rate on government bonds, (3) the case in which the fiscal policy authority has priority in adjusting the situation against the concern that the continuous creation of public debt may cause crowding out and inflation. Secondly I conducted the tests with Granger causality tests and impulse response function. The results are as follows; (1) The monetary authority could adjust the volume of government bonds in the secondary market. In fact, however, it is the fiscal authority that could reduce the rate of interest on government bonds, adjusting the level of the prices effectively. Moreover, though the tests didn’t find crowding out, the shortage of resources for the fiscal policy authority’s purchasing and underwriting government bonds is expected to lead to crowding out. (2) I reached the conclusion that the fiscal authority’s underwriting bonds would increase the price level without the increase of base money. These two observations show that the factors of crowding out and inflation are already involved in Japan due to the cumulative deficits. Therefore, I assert that neither the central bank’s underwriting government bonds nor creating expectation of inflation is appropriate to today’s Japanese economy, even though Japan is in a depressing situation due to the collapse of the “bubble economy”.