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Analysis

Deflation in Japan

by William Baunton

Wed 17 Sep 2014

Deflation in Japan Enlarge Chart loading Image

What the chart shows: Japan’s inflation (left axis) and birth rate minus death rate (right axis) from 1962 - 2012.

Why the chart is important: It is well known that Japan has been suffering from deflation for over two decades, a phenomenon that has always been feared by policy-makers around the world. Deflation is usually perceived as a problem associated with a weak economy suffering from a severe drop in aggregate demand (the US experienced deflation of around 10% from 1930-33, for example). There are many difficulties that come with deflation aside from output loss and reduced employment; it causes an arbitrary redistribution of wealth from borrowers to lenders due to unforeseen drop in prices and on a more basic level, adds to business costs due to changing prices, also known as ‘menu costs’.

The cause of Japan’s chronic, yet mild, deflation has never been definitively pinpointed; has a liquidity trap been caused by negative inflation or growth expectations? Has there been a permanent negative productivity shock? The most likely answer is that it is a combination of many factors; one is highlighted here. The population in Japan has been in decline since 2006-07 with the population over 65 rising. The death rate is now higher than the birth rate, with the World Bank estimating the population will be 120 million in 2050. These demographic changes lower the natural rate of interest and expectations of future growth. 

Sources: World Bank, BBC and BIS paper no. 70 - ‘Chronic deflation in Japan’ 2012 by Nishizaki et al.

Methodology: Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. The Laspeyres formula is generally used.

Crude death rate indicates the number of deaths occurring during the year, per 1,000 population estimated at midyear. Subtracting the crude death rate from the crude birth rate provides the rate of natural increase, which is equal to the rate of population change in the absence of migration.

Crude birth rate indicates the number of live births occurring during the year, per 1,000 population estimated at midyear. Subtracting the crude death rate from the crude birth rate provides the rate of natural increase, which is equal to the rate of population change in the absence of migration.