Center for Pacific Basin Studies

The Center for Pacific Basin Studies promotes cooperation among central banks in the Pacific Basin and provide insight into and analysis of economic policy issues affecting the region.

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Pacific Basin Notes

Occasional series of the FRBSF Economic Letter

COVID-19 Fiscal Expansion and Inflation Expectations in Japan

2022-20

Jens H.E. Christensen and Mark M. Spiegel | August 3, 2022

The Japanese government’s strong response to the economic fallout from COVID-19 presents an opportunity to examine whether expansionary fiscal policies raise long-term inflation expectations. Analyzing market-based estimates of long-term inflation expectations in Japan shows that announcements of government fiscal stimulus under COVID-19 had no meaningful impact on investors’ long-term inflation expectations. This illustrates the challenge of moving long-term expectations after they become anchored below a central bank’s inflation target, as they have been in Japan.

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Working Papers

Bank Risk-Taking and Monetary Policy Transmission: Evidence from China

Working Paper 2020-27

Li • Liu • Peng • Xu | August 2020

We present evidence that monetary policy easing reduces bank risk-taking but exacerbates capital misallocation in China after implementing the Basel III capital regulations in 2013. The new regulations tightened bank capital requirements and introduced a new risk-weighting approach to calculating the capital adequacy ratio (CAR). To meet tightened capital requirements, a bank can boost its effective CAR by raising capital or by increasing the share of lending to low-risk borrowers. Using confidential loan-level data from a large Chinese commercial bank, merged with firm-level data on a large set of manufacturing firms, we document robust evidence that a monetary policy expansion raises the share of new bank loans to state-owned enterprises (SOEs) after 2013, but not before, because SOE loans receive high credit ratings under government guarantees. Since SOEs are on average less productive than private firms, shifts in bank lending toward SOEs exacerbate capital misallocations, reducing aggregate productivity. We construct a two-sector general equilibrium model with bank portfolio choices and show that, under calibrated parameters, an expansionary monetary policy shock raises the share of bank lending to SOEs, leading to persistent declines in total factor productivity that partially offset the expansionary effects of monetary policy.

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