Japan's Persistent Deflation and Monetary Policy: Editors' Overview

• Date: 01 January 2014
• Author: Tsutomu Watanabe,Colin McKenzie,Shujiro Urata,Kazumasa Iwata,Takatoshi Ito
• Published date: 01 January 2014
• DOI: http://doi.org/10.1111/aepr.12040

Japan’s Persistent Deflation and

Monetary Policy: Editors’ Overview

Takatoshi ITO,1Kazumasa IWATA,2Colin MCKENZIE,3† Shujiro URATA4and

Tsutomu WATANABE1‡

1The University of Tokyo, 2Japan Center for Economic Research, 3Keio University and 4WasedaUniversity

JEL codes: C43, D12, D30, E3, E31, E5, E58, F41, J30, J60, O53

1. Japan’s Persistent Deflation and Monetary Policy

The Japanese economy has been in a liquidity trap for more than a decade. Consumer

price inflation has been below zero since the mid-1990s, indicating the emergence of

deflation. The rate of deflation measured by the headline consumer price index (CPI)

has been around 1% per year, which is much smaller than the rates observed in the USA

during the Great Depression. However, the Japanese deflation has lasted for more than

15 years, clearly indicating that it is much more persistent than US deflation. In respond-

ing to the emergence of deflation, the Bank of Japan (BoJ) cut its policy interest rate

several times until the rate finally reached the zero lower bound (ZLB) in February 1999,

and this was followed by the introduction of quantitative easing (that is, the large scale

purchase of assets by the BoJ to increase the amount of base money in the economy) in

March 2001. More recently, the BoJ set a 2% inflation target in January 2013, and

announced in April 2013 that it would seek to achieve this inflation target within two

years, by doubling the base money by March 2015 through large-scale purchase of

various types of assets, including Japanese government bonds, which is referred to as

quantitative and qualitative monetary easing.

The liquidity trap is a very rare phenomenon, and the current Japanese situation is

only comparable with the US experience during the Great Depression. However, similar

phenomena took place in the USA and European countries during the recent global

financial crisis and the European sovereign debt crisis. The rates of inflation in those

countries were low even before the crisis happened, but declined substantially due to

diminishing aggregate demand, and sometimes fell below the target level of inflation,

which was somewhere around 2%. In responding to this, the Federal Reserve cut its

policy rate several times until the policy rate reached the zero bound, and then moved on

to the adoption of quantitative easing in November 2008. Similarly, quantitative easing

has been adopted by the European Central Bank since May 2009 and by the Bank of

England since March 2009. Unprecedentedly, large-scale purchases of assets by the

central banks in those countries contributed to the recovery from the crisis, but also pro-

duced harmful side effects, including massive, hard-to-control money inflows into

emerging market economies.

†Correspondence: Colin McKenzie, Faculty of Economics, Keio University, 2-15-45 Mita, Tokyo

108-8345, Japan. Email: mckenzie@z8.keio.jp

‡TsutomuWatanabe was a guest editor for this issue of the Asian Economic Policy Review.

bs_bs_banner

doi: 10.1111/aepr.12040 Asian Economic Policy Review (2014) 9, 1–19

© 2014 The Authors

Asian Economic Policy Review © 2014 Japan Center for Economic Research 1

The policy rate had never hit the ZLB since the Great Depression.Why did this happen

again in Japan and in other industrial countries? This may be a big question to be asked.

The six papers in this issue address this question with a particular focus on deflation in

Japan. The specific questions these papers address include the following: Why has the

Japanese economy been caught in a liquidity trap for such a long period? What is the main

cause of deflation in Japan? How is deflation related to problems in the real side of the

Japanese economy,such as labor market conditions, low productivity growth, and demo-

graphic changes? Why did deflation take place in Japan,but not in other countries?

Nishizaki et al. (2014) overview the development of deflation in Japan since the mid-

1990s, and then investigate the mechanism through which deflation took place using the

New Keynesian Phillips Curve as a theoretical framework. They evaluate the importance

of each of the candidate factors (i.e. the decline in expected inflation, the presence of

wide output gap, and the yen appreciation). Imai and Watanabe (2014) pay attention to

the issue of CPI measurement to see how accurately the rate of deflation is measured by

the official CPI. Sudo et al. (2014) take an innovative approach to investigate the causes

of deflation. They carefully examine price behavior at the micro level, especially the fre-

quency of bargain sales, by employing data on the prices for individual products sold at

supermarkets. Their finding indicates that the deterioration of labor market conditions

yielded some downward pressure on the general price level. Kuroda and Yamamoto

(2014) also examine the role of labor markets, especially the role of nominal wage flex-

ibility, in the process of deflation. Abeand Shiotani (2014) investigate the implications of

deflation/inflation for income redistribution across heterogeneous households. Finally,

Shioji (2014) discusses policy options to stop deflation, with a particular focus on the

exchange rate channel, which is considered to be effective even when the policy rate is

already at the ZLB.

2. Summary of Papers and Discussions

This section summarizes the papers presented at the Seventeenth Asian Economic

Review Conference held in Tokyo on July 15, 2013, the comments bythe assig ned discus-

sants, and the general discussion of each paper.

2.1 Nishizaki, Sekine, and Ueno on chronic deflation in Japan

Japan has experienced deflation, defined by a sustained negative inflation rate, for 15

years. From 1998 to 2012, with a brief exception in 2006–2007, the Japanese CPI contin-

ued to decline. Since deflation was not experienced in advanced economies in the

postwar period, why deflation was observed in Japan is an important question. Uncover-

ing what are the adverse impacts of deflation on various aspects of the Japanese

economy, from consumption and investment behavior to the sustainability of the

pension system, are also important issues.

The overview paper by Kenji Nishizaki et al. (2014) examines the possible causes for

why price developments in Japan have been so weak for such a long time,referr ing tothe

recent literature, which by no means has a consensus view.

Editorial Takatoshi Ito et al.

© 2014 The Authors

Asian Economic Policy Review © 2014 Japan Center for Economic Research

2