Japan’s deflation: the role of wage costs

Abstract

Is weak demand pressure alone sufficient to explain Japan’s long-standing deflation? The empirical evidence, based on a structural VAR model consisting of productivity, wage costs and prices, provides the robust facts for understanding Japan’s deflation. It suggests that sluggish wage growth since the mid-1990s, along with productivity recovery from the collapse of the Japanese asset price bubble, contributed to the persistence of deflation, while weak demand pressure had a large negative implication for Japan’s inflation. Going forward, the result implies that the translation of productivity gains into adequate wage growth, in addition to boosting demand, is important to help bring a definitive end to Japan’s deflation.

Keywords:

• inflation
• output gap
• productivity
• structural VAR
• wages

JEL Classifications:

• E31

Notes

Any views expressed herein are those of the author and not of the Cabinet Office and the OECD. Any remaining errors are my own.

¹ The second sample period includes Japan’s twelfth  business cycle, during which Japan registered its first annual decline in GDP deflator, while excluding highly unusual developments during the period after the Lehman shock and a fortiori after the Great East Japan Earthquake.

² The model includes constant terms. Information criteria indicate that four lags are sufficient to capture the structural dynamics of the model.