Abstract
We discuss the effectiveness of monetary policy in the prolonged Japan's recession. Many researchers considered this topic, and a majority of previous papers denies the effectiveness of monetary policy in the deflation. Although the Bank of Japan always insists that monetary policy does not work well especially in the severe deflation, the role of money should not be ignored when we consider M. Friedman 's word ”Both inflation and deflation are monetary phenomenon.” We analyze Japan 's economy over the period from 1980q1 through 2009q4, and examine whether or not there exists a long-run equilibrium relationship between the monetary base and economic activity, paying a close attention to the precautionary money demand increased by the financial crisis in the recession. The survey data is used to estimate the precautionary demand. The result shows that the cointegration property among monetary base and economic activity still holds even after Japan 's economy fallen into the deflation in 1997, when the precautionary demand is taken into account. We also check the existence of the liquidity trap by the same model. The result denies the existence of the trap. Thus, we conclude that monetary policy is still effective and the BOJ' role is crucially important to combat against the prolonged recession.
