Chronic Deflation in Japan

• Author: Yoichi Ueno,Toshitaka Sekine,Kenji Nishizaki
• DOI: http://doi.org/10.1111/aepr.12041
• Published date: 01 January 2014
• Date: 01 January 2014

Chronic Deflation in Japan

Kenji NISHIZAKI, Toshitaka SEKINE† and Yoichi UENO

Bank of Japan

Japan has suffered from a long-lasting but mild deflation since the latter half of the 1990s. Esti-

mates of a standard Phillips curve indicate that a decline in inflation expectations, the negative

output gap, and other factors such as a decline in import prices and a higher exchange rate all

account for some of this development. These factors, in turn, reflect various underlying structural

features of the Japanese economy. This paper examines a long list of these structural features that

may explain Japan’s chronic deflation, including the zero lower bound on the nominal interest

rate, public attitudes toward the price level, central bank communication,weaker growth expecta-

tions coupled with declining potential growth or the lower natural rate of interest, risk-averse

banking behavior, deregulation,and the r ise of emerging economies.

Key words: deflation, inflation expectations, Japan, liquidity trap, monetary policy, Phillips curve

JEL codes: E31, E58, O53

1. Introduction

Why have price developments in Japan been so weak for such a long time? What can

leading-edge economic theory and research tell us about the possible causes behind these

developments? Despite the obvious policy importance of these questions, there is no

consensus among practitioners or in the academia. This paper is an attempt to shed

some light on these issues by relying on recent works on the subject in the literature.

The paper proceeds as follows. Section 2 presents some stylized facts regarding defla-

tion in Japan. It shows that Japan has indeed experienced long-lasting but mild deflation,

and that its weak price developments are not attributable to any specific item – this is the

case not only in a breakdown of time series data, but also in cross-country comparison.

The section also looks into the correlation of inflation with the output gap, the unem-

ployment rate, and money. Section 3 then explores the causes of prolonged deflation in

Japan based on the now-standard New Keynesian Phillips curve, examining each of the

explanatory variables – namely, inflation expectations, the output gap, and other factors

– in turn. In doing so, we not only describe developments in these variables, but also

We would like tothank Kazuo Ueda, Andrew Levin, Eiji Maeda, Etsuro Shioji, Nobutoshi Kitaura,

David Weinstein, Neil Ericsson, Hibiki Ichiue, the editors of the Asian Economic Policy Review

(AEPR), and the participants in the AEPR Conference, the BoJ-CARF Joint Conference, the BIS

Research Workshop, as well as those in seminars at Columbia University, the Federal Reserve

Board, and the Federal Reserve Bank of New York, for useful comments and discussions. We are

solely responsible for any remaining errors in the paper. The views expressed in this paper do not

necessarily reflect those of the Bank of Japan.

†Correspondence: Toshitaka Sekine, Bank of Japan, 2-1-1 Nihonbashi-Hongokucho, Chuo-ku,

Tokyo103-8660, Japan. Email: toshitaka.sekine@boj.or.jp

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doi: 10.1111/aepr.12041 Asian Economic Policy Review (2014) 9, 20–39

© 2014 The Authors

Asian Economic Policy Review © 2014 Japan Center for Economic Research

20

discuss what the driving forces underlying them are in order to discover the more funda-

mental reasons for the chronic deflation. Section 4 concludes the paper. Two appendices

document chronologies of the Bank of Japan’s (BoJ’s) communications on price stabil-

ity, as well as government and media reports that reveal public attitudes toward the price

level.

2. Stylized Facts

2.1 Price developments

Japan has suffered from long-lasting but mild deflation since the latter half of the 1990s

(Table 1). After reaching 11.6% in the first half of the 1970s, annual average consumer

price index (CPI) inflation rates declined, becoming around zero or slightly negative

from the middle of the 1990s. A similar trend can be observed for inflation rates calcu-

lated using the gross domestic product (GDP) deflator, although they tend to be some-

what weaker than CPI inflation. The weakness of these prices from the mid-1990s

onward becomes more evident once the hike of oil prices and the depreciation of the yen

against the US dollar are taken into account.

A breakdown of CPI inflation into its major components suggests that most of the

components contributed to the slowdown in CPI inflation from the mid-1990s onward.

For instance, durable goods prices, which had pushed down inflation already since the

mid-1980s, fell more rapidly in the 2000s. Price changes in other goods and services,

which used to raise inflation, became almost flat or turned negative in the 1990s. On the

other hand, the energy component raised inflation from 2000 onward, reflecting devel-

opments in commodity markets.

Tab le 1 Price developments (annual average, %)

1971–

1975

1976–

1980

1981–

1985

1986–

1990

1991–

1995

1996–

2000

2001–

2005

2006–

2009

CPI (less fresh food) 11.6 6.5 2.5 1.2 1.3 0.0 −0.4 0.0

GDP deflator 10.4 5.5 1.5 1.2 0.7 −0.9 −1.3 −0.9

Oil price 53.7 26.7 −4.3 2.6 −4.1 14.5 16.4 7.2

Yen/USD −3.4 −5.5 0.6 −7.6 −7.3 3.3 0.8 −4.7

Contribution to CPI

(less fresh food)

Energy 0.9 0.7 0.0 −0.2 0.0 0.0 0.1 0.1

Durable goods 0.3 0.1 0.0 −0.1 −0.1 −0.2 −0.2 −0.2

Other goods 6.3 2.3 1.3 0.5 0.4 −0.1 −0.2 0.2

Services 4.3 3.4 1.3 1.0 1.0 0.3 0.0 0.0

Notes: The CPI is adjusted so as to exclude the effects of changes in consumption tax rates and

subsidies for high school tuition. This applies when the CPI is quoted in later tables and figures.

Sources: Bank of Japan, Cabinet Office, and Ministry of Internal Affairs and Communications.

CPI, consumer price index; GDP, gross domestic product.

Kenji Nishizaki et al.Chronic Deflation in Japan

© 2014 The Authors

Asian Economic Policy Review © 2014 Japan Center for Economic Research 21