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The Reason Behind the Sustained Deflation in Japan


Usual Suspects:

  1. Bad business Decisions and Demography (Kosuke Motani-The author of “The real Face of Deflation”)

  2. Produce new luxury goods → ↑demand of wealthy old and ↑ wages of poor youth

  3. Similarly, BoJ governer, Masaaki Shirakawa, stated: downward trend in GDP growth caused by ↓in # of workers and declining productivity

  4. Note: Big part of the savings are in the hand of elders and Japan is a shrinking population

  5. Inflation Expectation (NSUK-2012)

  6. How far: This paper and Saito et al show that long run inflation expactations had fallen but did not go below negative territory. (Look at figure 3)

  7. Why:

  • CB decreased inflation target → ↓in people’s inflation expectations

  • CB’s inefficient communication strategy sent a deflationary signal to the public

  • Public’s perception of Japan prices are too high (Look at Figure 4)

  1. The Negative Output Gap: (Y-Y*) < 0

  2. Note: Remember Okun’s Law : (Y-Y*)/Y* = -(\beta)*(u-u*)

  • u*: natural rate of unemp.

  • Y*: potential output

  • \beta: constant derived from regression to show the link btw deviations from potential output and natural rate of unemp.

  1. It has been largely negative since 1990 (Look at Figure 5)

  2. Reasons of negative output gap:

  • Negative demand shocks resulting from

  1. collapse of asset price bubblein 1990s

  2. Japanesse financial crisis and Asian currency crisis in 1990s

  3. collapse of the US dotcom bubblein the early 2000s

  4. global financial crisis in the latter 2000s

  5. Decline in the natural rate of interest rate (liquidity trap) (Look at figure 10). (Watanabe 2012, Krugman 1998, Laubach and Williams 2013)

  • Note: Remember Fisher equation: i = natural interest rate + inflation expectations

  • However, whether the natural rate has declined is a debatable issue: Studies show that potential output has never been negative except Lehman crisis time. (Look at Figure 11)

  1. Link btw lower (but not necessarily negative) potential growth and the deterioration in the output gap via growth expectations

  • Saito et. al 2012: Weaker growth expectations sequeeze AD more than AS

  1. Permanent and negative productivity shock → narrow negative output gap → deflation

  • Impacts of population aging on demand side of the economy

* Graph Source: Nishizaki, Kenji, Toshitaka Sekine, and Yoichi Ueno. "Chronic deflation in Japan." Asian Economic Policy Review 9.1 (2014): 20-39.


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