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Monetary Policies In The Us And Japan

2222 words - 9 pages

This paper presents comparative analysis of Japanese and the US monetary policies during the recession in 1990s and focuses on transmission mechanisms used by central banks in conducting policy. In spite of some differences, two central banks employed the same instruments and were similar in their operating procedures. The implementation of monetary policy in the U.S was successful which led to increase in real GDP growth, decrease in unemployment, and low and stable inflation. However, monetary policy in Japan did not follow the same path. In our paper we endeavored to provide a response to the following question: “What does account for the successful implementation of the monetary policy in the US and failure in Japan in 1990?” The first part of the essay will focus on conduction of monetary policy in the U.S and would argue that accomplishments of the Fed can partially be attributed to good luck that comes from supply-side of the economy. Another explanation can be the fact that policymakers were able to increase responsiveness of interest rates to inflation. We will proceed with discussing conduction of monetary policy in Japan and will argue that failure of Japan cannot be attributed simply to the impotency of monetary policy when interest rates are low. Finally, the paper will discuss two different views, Keynesian and Monetarist that try to explain the failure of the Bank of Japan to stimulate the economy.
The Gulf War, which was led by the US against Iraq in response to Iraq`s invasion of Kuwait, had severe consequences for the U.S. economy. Notwithstanding the fact that the ground war lasted only for 100 hours, it resulted in uncertainty and upsurge in oil prices from $15 per barrel to over $35 per barrel, receding back only in 1991. Moreover, because of uncertainty, people were inclined to defer their spending until the aftermath of the conflict was clear. As a result of supply and demand shocks, the economy of the U.S. fell into recession, which lasted from July 1990 to March 1991 (Goodfriend, 2002). The data, provided by World Bank, suggests that annual GDP growth in the US fell sharply from 4% in 1989 to 0% in the late 1990 and begun to recover in 1991 (Figure 1). As for inflation rate, it jumped to 6.1% in 1990 (Figure 2). The general increase in price level combined with decrease in real GDP made recessionary gap even bigger.
The response of the Fed was to stimulate a weak economy by conducting expansionary monetary policy. What they decided to do is to buy bonds, thus, increase money supply. This, in turn, resulted in decrease in interest rate and increase in investment (Figure3). Furthermore, lower interest rate decreased the demand and increased the supply of dollars, thereby, lowering exchange rate. Lower exchange rate was followed by surge in net exports. Consequently, recessionary gap was closed. That is, the economy of the U.S. started to recover. In early 1994, the Fed opted for conducting contractionary monetary policy....

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