Deflation’s many effects

The IMF in its annual Article IV review of Japan (main report & background studies) “Mild deflation for over a decade has contributed to lower private investment and consumption by sustaining high real interest rates and raising real levels of debt. In addition, deflation has reduced tax revenue, and made it more difficult to contain real spending, which led to a rise in public debt-to-GDP. An exit from deflation is therefore essential to support the recovery and to facilitate fiscal consolidation.”

Deflation is also commonly considered a contributing factor to japan’s low growth rate over the last decade. The average growth rate during the decade starting in the year 2000 was 0.8%. This was low among the advanced countries and this rate was less than Germany, the UK, and the United States over the same time period. The Bank of Japan (BOJ) needs to step in with monetary policy to induce inflation. This year the BOJ instituted a policy objective of raising the price level to 1%. To accomplish this the BOJ has “expanded its Asset Purchase Program by ¥15 trillion this year in two steps and extended the maturity of JGB purchases from 1–2 years to 1–3 years.” This and other BOJ policies will raise the monetary supply by almost 5% of GDP this year.

Despite the BOJ’s steps to achieve 1% inflation, the IMF predicts only about .5% inflation over the next year and has suggested even more extensive monetary easing to achieve the 1% target inflation rate.

1 thought on “Deflation’s many effects

  1. the prof

    Re low growth, remember our models! — the lower investment you note in the first paragraph is one source. But remember too that with (i) falling population that number is better than it seems (though population growth in the EU is now low enough that the gap between overall GDP growth and per capita GDP growth, that wasn’t as true in 2000). Be careful too that you don’t accidentally match business cycle dates that lead you to compare a peak to a trough.
    Note that PM Abe is focused on this issue; it’s an important one, even if it’s hard to shift dynamics (embodied in “expectations”) after roughly 15 years of deflation.

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