This article documents time series evidence suggesting the case for a possible structural break in the role of Japan's monetary policy during the 1990s. It uses a simple vector autoregressive framework and offers some suggestive results: While a persistent effect of monetary policy on real output is detected over the full sample of 1975–1998 and the subsample that ends in 1993, such effect disappears with the recent subsample of the 1990s. The stability analysis also provides more specified evidence that there is a break in the reduced form dynamic system in 1995. Some interpretations are offered to intuitively support these findings. J. Japan. Int. Econ., December 2000, 14(4), pp. 366–384. Research Institute for Economics and Business Administration, Kobe University, Rokko, Nada, Kobe 657-8501, Japan Copyright 2000 Academic Press.
Money serves as a unit of account or numeraire; it also serves as a
medium of exchange and a store of value, though this is secondary. Sub-
stantive arguments for effective monetary policy have focused on money as
a unit of account.
Monetary policy can have real effects by altering the structure of payoffs
of assets, which determines the attainable reallocations of revenue across
contingencies: it alters the level of prices which, in turn, determines the real
payoff of nominal assets; the allocations of resources at equilibrium
associated with distinct asset structures are typically distinct. This argu-
ment, which had been put forward by Tobin [17], was formalized in theliterature on equilibria with an incomplete asset market and nominal
assets, first by Cass [2] and then by Balasko and Cass [1], Geanakoplos
and Mas-Colell [8], and the literature that followed. That the asset market
be incomplete is necessary: with a complete asset market, variations in the
structure of payoffs of assets can only be inessential. It is also necessary
that some assets be nominal: it was shown by Chamley and Polemarchakis
[3] that, with indexed assets, variations in the supply of money and the
level of prices fail to alter essentially the structure of payoffs of assets and
are neutral, which parallels the argument of Modigliani and Miller [13],
in corporate finance. The specification of the standard model of an
economy with an incomplete asset market in which money balances are in
zero net supply and monetary policy reduces to the exogenous determina-
tion of the level of prices is an abstraction: the features and conclusions of
the model carry over in tact either in economies, following Clower [5],
with a cash-in-advance technology of transactions, as in Dubey and
Geanakoplos [7] and Magill and Quinzii [11], or, following Samuelson
(1958), in economies with a demographic structure of overlapping generations,
which allow for money balances in positive net supply, as in Detemple
et al. [6].
When individuals are asymmetrically informed, rationality in the forma-
tion of expectations, following Radner [15], requires that individuals refine
their private information with the information revealed by prices. Prices of
assets and commodities do not convey only the aggregate scarcity of
resources: they convey information across individuals.
If individuals form expectations rationally, monetary policy is neutral
unless changes in the supply of money are stochastic and prevent
individuals from distinguishing real from monetary shocks; this was the
argument of Lucas [10]. Alternatively, as shown by Weiss [18], monetary
policy can be effective by allowing prices to reveal information private to
some individuals.
The information revealed by prices depends on the structure of assets
available for the transfer of revenue across date-events. As shown by
Chamley [4], different asset structures lead to qualitatively distinct
behavior of macroeconomic variables.
Earlier work by Mischel et al. [12], Polemarchakis and Siconolfi [14],
and Rahi [16] exploited the indeterminacy of equilibrium when assets are
nominal and the asset market is incomplete to show that, when individuals
are differentially informed, non-informative rational expectations equilibria
exist.
Here, an example illustrates that monetary policy can determine the
information revealed by prices, and, thus, it can have real effects.
There exists an open set of distinct, competitive equilibrium allocations
associated with fully non-informative rates of interest and a uniquecompetitive equilibrium allocation associated with fully revealing rates of
interest.
By construction, the equilibrium allocation with full revelation of infor-
mation coincides with the allocation that would have been obtained had
individuals had access to a complete system of insurance contracts prior to
the acquisition of private information: the effects pointed out by
Hirschleifer [9] are absent.
Monetary policy that varies only with public information can guarantee
the full revelation of information at equilibrium, which is optimal.
A generic set of monetary policies indeed attains full revelation but this
is not compelling, since monetary policy is not an exogenous, structural
parameter.
Full indexation need not attain full revelation and, as a consequence,
need not implement an optimal allocation.
