Monetary policy, land prices, and collateral effects on economic fluctuations: Evidence from Japan

This paper attempts to analyze empirically how impact on collateral values can magnify effects of monetary tightening on the economy. Theoretically, this paper is motivated by "financial accelerator" effects stemming from impacts of monetary policy on financing conditions. In this context, recent economic conditions in Japan deserve our special attention for several reasons. One, a large fraction of business investment financed by bank loans is secured by land. Two, excessively sharp increases in the land dependence of small firms with the asset price inflation in the late 1980s may make a collateral effect bigger, if it exists. Extending existing work to a model with land prices, I find a strong effect of monetary policy on land prices: monetary tightening associated with a rise in the short-term interest rate produces a significant and persistent decline in land prices. I then analyze a role of land prices in the monetary transmission mechanism. Two results are interesting. One, after monetary tightening, output falls. But the impact on output appears more severe and deeper than was predicted in existing studies. Two, the monetary policy shock turns out to be an important source of output variation, as opposed to the findings of existing work in which monetary policy explains output fluctuations very little. The implication is that together with reduced flows of credit after monetary contraction, movements in land prices may play a significant propagating role in the monetary transmission mechanism. (C) 1998 Academic Press.