Discussion Paper Series 2018-E-12

Unconventional Monetary Policy and the Bond Market in Japan: A New-Keynesian Perspective

Parantap Basu, Kenji Wada

In this paper, we set up a medium scale new-Keynesian dynamic stochastic general equilibrium (DSGE) model to analyze the effects of various phases of unconventional monetary policy (UMP) on the Japanese bond market. Our model has two novel features: (i) a banking friction in the form of an aggregate bank run risk to motivate commercial banks' demand for excess reserve, and (ii) dynamic linkage between Central Bank resource constraint and the government budget constraint via a transfer payment by the Central Bank to the Treasury. We do three policy simulations to analyze the effects of various phases of UMP shocks on the bond market, namely: (i) effect of a quantitative easing (QE) shock; (ii) the effect of a negative shock to the overnight borrowing rate; and (iii) the effect of a negative shock to the interest rate on banks' excess reserve (IOER). In light of these results, we do an evaluation of the recent yield curve control policy of the Bank of Japan.

Keywords: QE; QQE; Excess Reserve; Overnight Borrowing Rate; IOER; Yield Curve Control

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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