Is Japan’s Monetary Policy a Rational Expectations Saga?

In April 2023, Kazuo Ueda became the 32nd governor of the Bank of Japan (BoJ), which had become famous for adopting an ultra-dovish monetary policy. Japan had maintained a zero-interest-rate policy for years in order to achieve growth and take the economy out of deflation. Ueda had to decide whether to raise interest rates after achieving the bank’s inflation target of 2 per cent. This was a crucial decision as the United States and other countries had raised interest rates because of higher inflation levels caused by supply-side disruptions arising from the Russo-Ukrainian War. Japan’s continued low interest rates were causing capital to flow out of the country in search of better returns, generating a further depreciation of the yen and gravely impacting the import costs of basic necessities like food and fuel. Historically, any indication of an interest rate hike in Japan had impacted expectations and sentiment so profoundly that it had led to a freefall in the consumer price index, leading to deflation and eliminating growth prospects. However, with Japan experiencing positive growth rates, inflation above the targeted rate, and a much-anticipated wage hike, it was time to rethink the country’s interest-rate policy.

The target audience for this case is students of post-graduate management and economics programs. This case is suitable for courses on monetary economics, macroeconomics, applied macroeconomics, and international economics. Students are expected to have a prior understanding of concepts such as national income accounting, gross domestic product (GDP), inflation, aggregate demand, aggregate supply, money multiplier, exchange-rate determination, and balance of payment. Students will learn to do the following by working through the case and related assignment questions:<ul><li>Explain the application of rational expectations theory in anchoring inflation expectations.</li><li>Analyze the linkages between monetary policy and exchange-rate mechanisms.</li><li>Assess monetary policy transmission mechanisms using interest rates, exchange rates, and inflation.</li></ul>

• Rational Expectations Theory
• Monetary Policy
• Zero Interest Rate Policy