Good Deflation/Bad Deflation and Japanese Economic Recovery

Abstract

Many economists dismiss the role of positive supply shocks as a cause of Japan’s deflation. Indeed, they sometimes attribute the long delay in Japan’s recovery to the mistaken view that Japan’s deflation reflects an acceleration of technological progress. Whatever the current situation in Japan, however, economic history certainly suggests that technological progress can go hand in hand with general deflation. Conducting a VAR analysis using very detailed information about the components of Japan’s consumer price index, this paper finds that short-run shocks to Japan’s relative price structure persist in the long run. Given this finding, it is possible to conclude that such shocks are real in origin and reflect technological change. As no effort has yet been completed to show the full extent to which technological change is driving short-run relative price change in Japan compared with other factors, and the full extent to which relative price changes are driving aggregate price change compared with other factors, the policy implications of these findings are unclear. What is clear is that it is a mistake to dismiss out of hand the possibility that technological shocks are playing an important role among other forces in Japan’s current deflation.