A Macro-Finance Analysis of the Term Structure and Monetary Policy in Japan: Using a Model with Time-Variant Equilibrium Rates of Real Interest and Inflation and with the Zero Lower Bound of Nominal Interest Rates ♦

We study the term structure of interest rates and monetary policy in Japan empirically, using a macro-finance model. In particular, we investigate whether or not Japan's low long-term interest rates can be explained with economic rationality by taking into account some key features of the economy: possible time-variability of perceived equilibrium rates of real interest and inflation, the effect of the zero lower bound of nominal interest rates, and the effect of the zero interest rate commitment by the Bank of Japan. We are also interested in the estimation of the macroeconomic structure based not only on macroeconomic data but also on market interest rate information. Specifically, we use a New Keynesian-type macro structural model and an affine diffusion model of the term structure, taking into account the non-linearity related to the zero interest rate constraint. We estimate the models simultaneously using monthly time-series data including the estimated monthly series of GDP. We find that both the perceived equilibrium rates have been time-variant since the end of 1980s, and that the macro-finance model gives us a rational explanation of low interest rates although there are some caveats in interpreting the results. We also carry out a decomposition of the interest rates into various components, and analyze the causes of model errors.