Taylor Rule During the Zero or Low Interest Rate Era: The Recent Japanese Case

The Taylor rule has been discussed a lot in theoretical and empirical studies. However, interest rates are quite low all over the world. Japan is no exception. Instead of traditional monetary policy based on interest rates, unconventional monetary policy based on money has been ongoing. This paper investigates whether the Taylor rule fits well in the recent Japanese case. With some other variables added to the Taylor rule along with price gap and output gap, the augmented Taylor rule is examined empirically. The empirical results show that the traditional Taylor rule is more appropriate than most augmented ones; however, exchange rate should be taken into account in determining monetary policy. Moreover, a more aggressive monetary policy from the latter part of the 2000s is needed.