The Effectiveness Of Monetary Policy Under Deflation

Deflation is a phenomenon of successive decreasing in the general prices of goods and services. Chinese economy has appeared a mild deflation since the latter half of 1997. Harnessing deflation has become an important goal of monetary policy hi China. Therefore, an exploration of the effectiveness of monetary policy under deflation is of great importance.In macro-economic theory, efficiency of monetary policy refers to the effect of monetary policy on real variables such as real output, employment etc. Keynesianism thought that monetary policy was effective before full-employment, but full-employment was a rare phenomenon. Fredman considered that money wasn't neutral in short- run but it was neutral in long-term. Monetary policy is a short-run policy of "adaptive strategy" in essence. Monetary long-term neutrality can't influence the policy effectiveness of the monetary short-term non-neutrality. In the 1970s, neo-classic school put forward and demonstrated the monetary policy ineffectiveness proposition. Neo-classic macroeconomists such as Lucas etc deemed that systematized monetary policy of monetary authorities couldn't even affect output and employment in short-term, only unanticipated monetary policy could affect output and employment hi short-term. In the paper the monetary policy ineffectiveness proposition can't repudiate the effectiveness of the China's monetary policy under deflation because of the imperfect markets and the information asymmetry.This paper analyzes the state of effectiveness of the Japan's monetary policy during deflation. The Japan's monetary policy has stepped into liquidity trap. The "zero interest rate policy" can't increase investment and stimulate the economic growth. In China, the action of evading financial risk by bank system and the existence of credit rationing account for the failure of the fine tuning by central bank's short term expansionary monetary policy since 1997. But the China's interest rate has not stepped into liquidity trap. Monetary policy is still effective. This paper applies IS-LM model to demonstrate the effectiveness of China's monetary policy. Finally, this paper proposes some recommendation for the way how to strengthen effectiveness of monetary policy during deflation.