**Title**

Liquidity Trap and the Stability of Money Demand: Is Japan Really Trapped at the Zero Bound?

**Abstract**

Is the Japanese economy really trapped at the zero interest rate bound?
The question seems particularly important because recent theoretical discussions
on liquidity traps suggest that undesirable dynamics such as "deflationary
spiral" are likely to occur when the economy reaches the lower zero
bound. This paper attempts to answer the above question by analyzing the
stability of an equilibrium money demand relationship in Japan. Specifically,
it performs a formal analysis on the presence and stability of cointegration
in M1 demand in Japan and argues that the answer seems negative. With the
double-log specification, a cointegrating M1 relationship exists and is
found to be stable (i.e. no break in the interest elasticity) even after
1995 when nominal rates were lowered to a decimal point level or virtually
"zero percent".

Ryuzo MIYAO

Research Institute for Economics and Business
Administration

Kobe University

Rokkodai-cho, Nada-ku, Kobe

657-8501 Japan

Phone: (81) 78 803 7036

Fax: (81) 78 803 7059