A couple of days ago I stumbled on a comment from George Selgin that made me think of deflation in Japan. Here is George’s comment (from 2009):
“From roughly 1999 through 2005, on the other hand, Japan’s deflation rate did more-or-less match its rate of productivity growth. But by then the Japanese economy was growing again, if only modestly. This happened in part precisely because the Japanese government had at last turned to quantitative easing: had it not done so Japan’s deflation might well have proceeded well beyond productivity-norm bounds. In short, Japan’s case suggests that deflation (insofar as it doesn’t exceed the bounds of productivity growth) and zero interest rates are each of them red-herrings: Japan’s economy tanked when its NGDP growth rate fell dramatically, and it began to recover when the rate stabilized again, even though it stabilized at a very low value. (It has since slumped badly again.)”
So what George is saying is effectively saying is that at least for a period Japan did de facto have a “productivity norm”. I was unaware that George had that view when I sometime ago commented on Japanese deflation. In my comment “Japan’s deflation story is not really a horror story” I argued that “obviously, Japan has deflation because money demand growth consistently outpaces money supply growth. That’s pretty simple. That, however, does not necessarily have to be a problem in the long run if expectations have adjusted accordingly. The best indication that this has happened is that Japanese unemployment in fact is relatively low. So maybe what we are seeing in Japan is a version of George Selgin’s “productivity norm”. I am not saying Japanese monetary policy is fantastic, but it might not be worse than what we are seeing in the US and Europe.”
I have to admit that I wrote that without having a real good look at the Japanese data and before I had written about decomposition of inflation between demand inflation and supply inflation. So when I read George’s comment I decided to have a look at the Japanese data once again and do a Quasi-Real Price Index for Japan.
The graph below tells the Japanese deflation story.
The graph shows that George is a bit too “optimistic” about how long Japan have had a productivity norm – while George claims that this (unintended!) policy started in 1999 that is not what my decomposition of Japanese inflation shows. In fact Japan saw significant demand deflation until 2003. That said, the period 1999 until 2008 was clearly less deflationary than was the case in the 1990s when monetary policy was strongly deflationary and we saw significant demand deflation. However, it is clear that George to some extent is right and there was clearly a period over the past decade where monetary policy looked liked it followed a productivity norm, but it is also clear – as George states – that from 2007/8 monetary policy turned strongly deflationary once again.
Overall, I am pleasantly surprised by the numbers as it very clearly illustrates the shifts in monetary policy in Japan over the past 30 years. First, it is very clear how Japanese monetary policy was tightened in 1992-93 and remained strongly deflationary until 2002-3, In that regard it is hardly surprisingly that the 1990s is called Japan’s “lost decade”. The fault no doubt is with Bank of Japan – it kept monetary policy in a deflationary mode for nearly a decade.
However, in March 2001 the Bank of Japan announced a policy of quantitative easing. For those who believe that QE does not work they should have a look at my graph. It is very clear indeed that it does work – and from 2002 demand deflation eased off. This by the way coincided with a relatively strong rebound in Japanese growth and the Japanese economy kept on growing nicely until the Bank of Japan reversed its QE policy in 2007. Since then deflation has returned – and once again the Bank of Japan is to blame.
But once again George Selgin is correct – yes, we continued to have headline deflation in the period 2001-2007, but from 2003 this deflation was primarily a result of a positive productivity shock. In that sense the Bank of Japan had a period where it followed a productivity norm. The problem was that this was never a stated policy and as a result Japan was once allowed fall back to demand deflation from 2007.