Exchange Rate Adjustment, Monetary Policy and Fiscal Stimulus.pdf

a, b, a b ∗Corresponding author: Research Institute for Economics and Business Administration, Kobe University, 2–1, Rokkodai, Nada, Kobe, 657–8501, Japan. E–mail: shibamoto@rieb.kobe-u.ac.jp. /:+81-78-803- 7008. †Institute for Monetary and Ecoomic Studies, Bank of Japan, 2–1–1, Nihonbashi-Hongokucho, Chuo, Tokyo, 103–8660, Japan, E–mail: masato.shizume@boj.or.jp. A veteran finance minister, Takahashi Korekiyo, brought an early recovery for Japan from the Great Depression of the 1930s by prescribing a combination of expansionary fiscal, exchange rate, and monetary policies. To explore the comprehensive transmission mech- anism of Takahashi’s macroeconomic policy package, including the expectation channel, we construct a structural vector auto-regression (S-VAR) model with three state variables (output, price, and the inflation expectations) and three policy variables (fiscal balance, exchange rate, and money stock). Our analysis reveals that the exchange rate adjustment undertaken as an independent policy tool had the strongest effect, and that changes in people’s expectations played a significant role for escaping from the Great Depression. During the second half of 1931, in particular, speculation on Japan’s departure from the gold standard and the inflation that was likely to