The Japanese Quantitative Easing Policy under Scrutiny: A Time-Varying Parameter Factor-Augmented VAR Model

Interest rates in several countries have recently been decreased to exceptionally low levels and a Quantitative Easing Monetary Policy (QEMP) has been adopted by most major central banks. In this context this paper is very actual, as it sheds some light on the effectiveness of the Japanese use of QEMP, which is the only experience we can learn from. This paper employs a Time Varying Parameters Factor-Augmented VAR (TVP-FAVAR) model to analyse monetary policy shocks in Japan. This model allows us to explore the effect of QEMP on a large number of variables. Our analysis delivers four main results. First, unsurprisingly, our results suggest that the best model to specify the Japanese monetary policy during the two last decades is a model where all of parameters vary over time. Second, the effect of QEMP on activity and prices is stronger than previously found. In particular, we find a significant price reaction to a monetary policy shock. Third, in contrast to previous work, there is a detectable efficiency of the portfolio-rebalancing channel, which could have a role in transmitting the monetary policy shocks. Fourth, while the policy commitment succeeds in controlling private and business expectations, these effects are not transmitted to the long-end of the yield curve.