Posted by: Dirk | January 22, 2013

Spot the liquidity trap

The NY Times reports on the new strategy of the Bank of Japan:

The Japanese central bank on Tuesday set an ambitious target to defeat the nation’s crippling deflation and pledged to extend indefinitely its program to pump money into the economy, following intense pressure from the country’s audacious new prime minister, Shinzo Abe.

In a joint statement with the government, the Bank of Japan said it was doubling its inflation target to 2 percent and said it would “pursue monetary easing and aim to achieve this target at the earliest possible time.”

The bank also said it intended to remove any time limit from its program of purchasing government bonds and other assets. The bank’s board voted to keep its benchmark interest rate at a range of zero to 0.1 percent.

According to neo-classical ideas, this is an announcement of an increase in the monetary aggregate. Additionally, the Bank of Japan announced a higher inflation target. Sure enough, bond prices must be falling and effective interest rates of bonds – bond yields – must be rising to reflect the increase in expected inflation. The last paragraph of the article gives us some idea about the market reaction:

Yields on 10-year Japanese government bonds were largely unchanged, with a benchmark issue ending trading at 0.730 percent, down 0.005 percentage points from Monday’s close.

Read Richard Koo. Read John Maynard Keynes. Read Robert Skidelsky. Read Marc Lavoie. Read Axel Leijonhufvud. Read Randall Wray. Then: enter discussions.

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