Japan’s deflation story is not really a horror story

Many economists – including some Market Monetarists – tell the story about Japan’s economy as a true horror story and there is no doubt that Japan’s growth story for more than 15 years has not been too impressive – and it has certainly not been great to have been invested in Japanese stocks over last decade.

Some Market Monetarists are explaining Japan’s apparent weak economic performance with overly tight Japanese monetary policy, while others blame “zombie banks” and continued deleveraging after the bubble in to 1990s. I, however, increasingly think that these explanations are wrong for Japan.

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.

The main reason Japan has low growth is demographics. If you adjust GDP growth for the growth (or rather the decline) in the labour force then one will see that the Japanese growth record really is not bad at all – especially taking into accord that Japan after all is a very high-income country.

Daniel Gros, whom I seldom agrees with (but do in this case), has done the math. He has looked Japanese growth over the last decade and compared to other industrialized countries. Here is Gros:

“Policymaking is often dominated by simple “lessons learned” from economic history. But the lesson learned from the case of Japan is largely a myth. The basis for the scare story about Japan is that its GDP has grown over the last decade at an average annual rate of only 0.6% compared to 1.7 % for the US. The difference is actually much smaller than often assumed, but at first sight a growth rate of 0.6 % qualifies as a lost decade…According to that standard, one could argue that a good part of Europe also “lost” the last decade, since Germany achieved about the same growth rates as Japan (0.6%) and Italy did even worse (0.2 %); only France and Spain performed somewhat better…But this picture of stagnation in many countries is misleading, because it leaves out an important factor, namely demography…How should one compare growth records among a group of similar, developed countries? The best measure is not overall GDP growth, but the growth of income per head of the working-age population (not per capita). This last element is important because only the working-age population represents an economy’s productive potential. If two countries achieve the same growth in average WAP income, one should conclude that both have been equally efficient in using their potential, even if their overall GDP growth rates differ…When one looks at GDP/WAP (defined as population aged 20-60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan’s overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population…The difference between Japan and the US is instructive here: in terms of overall GDP growth, it was about one percentage point, but larger in terms of the annual WAP growth rates – more than 1.5 percentage points, given that the US working-age population grew by 0.8%, whereas Japan’s has been shrinking at about the same rate.”

So it is correct that Japanese monetary policy was overly tight after the Japanese bubble bursted in the mid-90ties, but that is primarily a story of the 90s, while the story over the last decade is primarily a story of bad demographics.

We can learn a lot from Japan, but I think Japan is often used as an example of all kind of illnesses, but few of those people who pull “the Japan-card” really have studied Japan. Similar for me – I am not expert on the Japanese economy – but both the monetary and the deleveraging explanations for Japan’s low growth during the past decade (not the 90ties) I believe to be wrong.

The Great Depression as well as the Great Recession are terrible examples of the disasters that the wrong monetary policy can bring and so is the Japan crisis in the mid-90s, but we need to make the right arguments for the right policies based on fact and not myth.

PS in Daniel Gros’ comment on Japan he makes some comments on the effectiveness of monetary policy. He seems to think that monetary policy is impotent in the present situation. I strongly disagree with that as I believe that monetary policy is in fact very effective in increasing nominal income growth as well as inflation. The liquidity trap is a myth in the same way the Japan growth story is a myth.

Leave a comment


  1. Alex Salter

     /  October 16, 2011

    Agreed about the liquidity trap. If the rest of the economic profession takes only one thing away from Market Monetarism, I hope it’s that the interest rate is not the only, or even the main, mechanism through which monetary policy works.

  2. Richard A.

     /  October 16, 2011

    The number of hours worked per worker has declined in Japan over the past coupe of decades. An even better measure for the Japanese would be real growth in hourly wages.

  3. Richard, I agree, but I guess that is also the case for most European nations. But again, I think that would just further confirm my point.

  4. Farid Elwailly

     /  October 17, 2011

    I gather from your post that targeting nominal GDP/WAP might be a better long term monetary policy than targeting NGDP to say 5%. This is especially true of countries going through a demographic change such as the U.S. where the baby boomers are retiring.

  5. Farid, I agree that a nominal GDP/WAP target probably would be preferable to a “normal” NGDP target. That said, to me the most important thing is that a transparent nominal anchor is in place – whether it is NGDP or NGDP/WAP or it is 3 or 5% is in my view less important. I will in the future try to do some posts on would should be the prefered target. Furthermore, what might be best for a country might not be the best for a small open economy like Iceland or a catching up Emerging Market like Turkey or Brazil.

  6. Basil H

     /  June 27, 2013


    I don’t know if you’ll see this, but I’m curious if you have any thoughts on this now, 1.5 years later. Japanese financial markets have reacted incredibly positively to the monetary measures Abe’s BOJ has taken. This would seem to indicate that markets believe that the Japanese economy has suffered due to incompetent central banking.

  7. I delight in, cause I found just what I used to be looking for.

    You’ve ended my 4 day long hunt! God Bless you man. Have
    a nice day. Bye

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