Budget Deficits and Inflation: A Theoretical and Empirical Survey

Japan's fiscal position is deteriorating continuously, and some argue that a debt write-off through managed inflation will be inevitable if public debt is to increase at the present pace. This article will first examine if inflation is an inevitable component of the attempt to solve the current government debt problem by looking at the history of debt reduction in other countries. Next, it will evaluate the economic theory on the interdependence between fiscal and monetary policies in light of the historical experience of inflation. In so doing, it finds that the gold standard imposed discipline on both fiscal and monetary policies while under the floating exchange rate regime budget institutions and the central bank system served as a guidepost to economic policy-making as an alternative to the gold standard. Based upon these theoretical historical and institutional findings, it will conclude by reflecting on the ways in which the experience of other countries can be useful for evaluating Japan's situation.

Money Demand near Zero Interest Rate: Evidence from Regional Data

Using Japanese regional data, we have obtained estimates of the income elasticity of demand deposits that are positive, have values that are close to one, and are statistically significantly different from zero, not only during the period of the low interest rate policy implemented after 1995 but also during the period of the "zero interest rate policy." The stable relationship obtained from regional data could provide useful information by which to judge the stability of the money demand function.

Nonstationary Time-Series Modeling versus Structural Equation Modeling: With an Application to Japanese Money Demand

The issues of identification, estimation, and statistical inferences of nonstationary time series and simultaneous equation models are reviewed. It is shown that prior information matters and the advantage of dichotomization of the traditional autoregressive distributed lag model into the long-run equilibrium relation and the short-run dynamic adjustment process as an empirical modeling device may be exaggerated. A Japanese money demand study is used to illustrate that a direct approach yields a more stable long-run and short-run relationship and has better predictive power than the approach of letting the data determine the long-run relationship and modeling the short-run dynamics as an adjustment of the deviation from its equilibrium position.

Policy Duration Effect under the Zero Interest Rate Policy in 1999-2000: Evidence from Japan's Money Market Data

This paper quantifies the policy duration effect of the zero interest rate policy implemented in Japan from February 1999 to August 2000. Our empirical analysis shows that the policy duration effect observed in Japanese financial markets emerged via the expectations channel on the future course of monetary policy actions, supplemented significantly by liquidity effects in the severe financial conditions. This finding leads to the policy implication that the effectiveness of the zero interest rate policy depends crucially on the financial and economic conditions.

Do Currency Regimes Matter in the 21st Century? An Overview

This paper selectively reviews the recent literature on currency regimes in Europe, the Americas, and East Asia. We argue that, given the global interdependence among today's economies, currency regimes should always be evaluated in relation to monetary policy, fiscal policy, structural policies, and the working of financial markets. Thus, currency regimes do matter and are a relevant concern for policymakers.

The Big Mac Standard: A Statistical Illustration

We demonstrate a statistical procedure for selecting the most suitable empirical model to test an economic theory, using the example of the test for purchasing power parity based on the Big Mac Index. Our results show that supporting evidence for purchasing power parity, conditional on the Balassa-Samuelson effect, depends crucially on the selection of models, sample periods and economies used for estimations.Big Mac Index, Purchasing Power Parity, Panel Data

Demand for Currency, New Technology and the Adoption of Electronic Money: Evidence Using Individual Household Data

Accurate information on money demand is essential for evaluation of monetary policy. In this regard, it is important to study the effect of financial innovation to money demand. We investigate the effect of a new form of such technology, electronic money, to money demand. Specifically, we estimate currency demand functions conditional on electronic money adoption using unique household-level survey data from Japan. We obtain the following results. First, currency demand indicates that average cash balances do not decrease with the adoption of electronic money. Rather, it seems to increase under some specifications. Second, households at the lowest quantile of the cash balance distribution tend to have higher cash balances after adopting of electronic money. These findings indicate that consumers do not significantly substitute cash holding with e-money holding despite the rapid diffusion of electronic money among households.Currency Demand, Transaction Demands for Money, Electronic Money

Japanese Demand for M1 and Demand Deposits: Cross-Sectional and Time-Series Evidence from Japan

We investigate the relationship between money, short-term interest rates, and scale variables. We use three monetary aggregates: Ml, demand deposits, and cash currency in circulation. Regional cross- sectional data yield stable estimates of the income elasticity of demand deposits that are positive and close to unity. We impose the estimated income elasticity obtained from cross-sectional data and estimate double- log interest rate elasticities of demand for Ml velocities and demand- deposit velocities using time-series data.

Effects of External Debt on Domestic Resource Allocation in a Small Open Economy with Limited Access to the World Capital Market

This paper studies a small open economy with a large external debt. It begins by considering the long-term effects of shocks in the international capital market and domestic fiscal policy on the amount of outstanding external debt and the domestic reallocation of resources between the tradable and non-tradable goods sectors theoretically. Then, numerical examples on various shocks are illustrated to help understand those theoretical predictions. For example, an exogenous increase in government expenditures, together with an increase in the external borrowing rate, requires resource reallocation between the tradable goods sector and the non-tradable goods sector as well as a small amount of external borrowings to shift toward the new stationary equilibrium, whose welfare level worsens.

Asymmetric Shocks and Regional Risk Sharing: Evidence from Japan

We use the methodology of Kalemli-Ozcan, Sorensen, and Yosha ( 2003) to calculate the degree of insurance among the Japanese prefectures. Prefectural-level data for fiscal years 1975 to 1999 are used to analyze the impact of idiosyncratic shocks to regional income. The results indicate that about 20 percent of idiosyncratic shocks to regional income are absorbed by inter-regional income insurance through the capital market, about 10 percent is absorbed by the national government through the inter-regional tax transfer system, and about 60 percent is absorbed as a result of changes in saving and dissaving.