Ratio Working Papers
No 23:
Deflation and Japan Revisited
Richard C.B. Johnsson ()
Abstract: Deflation counts among the worst things that could happen
to an economy, the conventional wisdom tells us. But are falling prices
really that bad? According to the Austrian School of Economics, this is not
necessarily the case. A distinction is commonly made between (1) growth,
(2) cash-building, (3) bank credit and (4) confiscatory deflation. When it
comes to the first three kinds, falling prices are regarded as benign free
market responses to changing circumstance, whether these are positive or
negative by themselves. When it comes to the latter, it is often regarded
as something negative. Lately, the word deflation has become almost
synonymous with Japan and its economic problems. In this paper, the
development of the Japanese economy of 1990-2001 is revisited. While
consumer prices fell in 1995 and 1999-2001, if other prices are taken into
account, it appears that the overall price level actually fell during most
of the years throughout the period, 1997 and 2000 being exceptions. When it
comes to the causes of the deflation, any confiscatory deflation created by
the government is ruled out, since the money supply has been rising
throughout the period. Instead, it is suggested that the deflation of 1994,
1995 and 1996 was exclusively caused by rising supply, i.e. there was
growth deflation. This could also have been the case in 1991 and 1992, but
the evidence is somewhat inconclusive. Moreover, deflation in 1993, 1998
and 2001 appears exclusively to have been caused by falling aggregate
demand, suggesting cash-building or bank credit deflation. Finally,
deflation in 1999 might have been caused by a combination of growth,
cash-building and bank credit deflation. In all of these cases, the falling
prices are to be regarded as benign. Although based on the same set of
data, these findings diverge sharply from the official Japanese view of the
economy at the time. This is ascertained by studying the official records
of the time the consumer price index moved into the negative domain for the
first time recorded. Instead of seeing this as something possibly benign,
the conventional fear of deflation on the part of the Bank of Japan came to
dominate its actions. And if it is true that falling prices are a benign
response to the changes that actually occurred in Japan at the time, then
any measures taken to make prices not fall cannot be of the benign nature.
And if there were one thing most economists would agree on it would
probably be that Japan’s economic malaise is not over. This seems to be an
important lesson for the future – preventing a free market adjusting,
including deflation, to changing circumstances could possibly prevent or
prolong a recovery.
Keywords: deflation; inflation; Japan; prices; GDP; GDR; liquidity trap; (follow links to similar papers)
JEL-Codes: E31; E42; E52; E58; (follow links to similar papers)
16 pages, May 8, 2003, Revised April 29, 2204
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- This paper is forthcoming as:
-
Johnsson, Richard C.B., 'Deflation and Japan Revisited', Journal of Monetary Economics.
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