IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history
The Bank of Japan cut its policy interest rate close to zero in the later 1990s, yet deflation and weak demand persisted. Which conclusion is most consistent with this experience?
Japan's experience suggests monetary policy can lose traction when nominal rates reach near zero, as in a liquidity trap. With damaged banks and weak borrowing demand, further easing could not stimulate spending, so deflation and stagnation persisted despite very low rates.
- AMonetary policy can lose effectiveness near a zero lower bound, particularly in a liquidity-trap setting with weak credit demand and supplyCorrect
- BInterest rates have no influence on investment under any circumstances
- CDeflation always results from excessive government spending
- DA zero interest rate guarantees a rise in inflation within one year
- Fiscal policy cannot affect aggregate demand in any economy
Explanation
With nominal rates near zero, further cuts are impossible, and with damaged bank balance sheets and pessimistic expectations, low rates failed to revive borrowing. This is the liquidity-trap argument. The other options are absolute claims that Japan's experience does not support.
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