Is Japanese stagnation demand-side or supply-side?

by on July 15, 2013 at 3:45 pm in Economics, History | Permalink

Here is an excellent post by Noah Smith on that topic.

Here is one bit:

It seems to me that the standard New Keynesian sticky-price story just cannot explain Japan. The “short run” for Japan is over and done. We are not looking at a “short-run” fluctuation caused by sticky prices.

This has implications for policy. It means that we can’t expect the “first arrow” of Abenomics – quantitative easing – to boost the real economy through the kind of channel described by a New Keynesian or AD-AS model. It might do so through some other channel, but how exactly that will work is not clear.

Here is another bit:

But I don’t think Japan is living in an RBC world either. Because in an RBC world, keeping interest rates at zero for decades, and printing a bunch of money (as the Bank of Japan did in the mid-2000s), should cause inflation (without helping growth). Instead, we see persistent deflation. So an RBC model of the common type can’t be describing Japan’s world either.

Here is his conclusion, with which I very much agree:

I’m not sure I know any model that describes Japan; maybe we don’t have one. But my guess is that it’s a world in which “Aggregate Demand” and “Aggregate Supply” are not as distinct entities as they are in Econ 102. In an AD-AS framework, either the AD curve or one of the AS curves shifts on its own. But in Japan, it may be that what look like supply shocks (falling productivity) and what look like demand shocks (deflation) may actually be due to the same cause.

And whatever world Japan is living in may have multiple equilibria. It may be that Japan is trapped in a “bad equilibrium”, and it will require a “big push” to kick it back to the “good equilibrium”. In fact, that seems to me to be the implicit premise of Abenomics.

In any case, we shouldn’t be thinking about Japan solely in terms of our standard textbook models. The real world appears to be much weirder than those toy environments.

david July 15, 2013 at 3:53 pm

I recall sunspot models were popular amongst New Keynesians in the late 1980s and early 1990s, back when the primary focus was trying to explain Eurosclerosis, and the DSGE framework hadn’t quite taken over all of New Keynesian analysis.

Adamo July 15, 2013 at 3:55 pm

Not trying to troll here… Genuinely looking for an answer. Has Japan inflated enough? Isn’t the common criticism among market monetarists that BOJ hasn’t been proactive enough?

To me, that’s the only plausible (known) explanation remaining. I am hoping someone can explain why Noah (and Tyler) think that’s wrong….

GeorgeDoehner July 15, 2013 at 4:51 pm

Utopians always say the answer is more. I recall in the Cold War days the Left would argue that the defect in the Soviet system was that is was insufficiently Marxist. In America, the answer to government created social pathology is always more government. It is a natural consequence of looking through the wrong end of the telescope.

Japan has a zombie economy due to massive debt, public and private. The solution is unlikely to be more debt, but that’s the argument from the central planners. Krugman has made similar arguments about the stimulus bill in America. He says it failed because it was too small. One suspect that no combination of size and results would lead him to say something other than “more!”

msgkings July 15, 2013 at 4:55 pm

You may have the causal arrow in the wrong direction, perhaps the massive debt in Japan is because they have a zombie economy? Or more specifically, an aging and depopulating economy? So they borrow to maintain consumption without enough young people to create wealth?

GeorgeDoehner July 15, 2013 at 9:07 pm

I don’t. I can think of a number of reasons for the public debt problems. The same is true in the US and Europe. If you want to get to the first cause you can start with the Louvre Accords, but that’s not the root. Modern currency arrangements are a reaction to the defects of managerial socialism. None of which is on point. Today. Japan’s problem is the massive debt.

Andrew' July 16, 2013 at 6:07 am

Unencumbered by any mainstream economics ideas, I suspect the question might be, with a banking-fiat system, is it possible to inflate enough?

Boonton July 16, 2013 at 1:06 pm

“I don’t. I can think of a number of reasons for the public debt problems.”

What public debt problems? Is there evidence Japan is hyperinflating as it tries to print money to manage its debt? Is there evidence Japan’s suffering massive interest rate spikes as investors refuse to turn over debt?

Or are the public debt problems simply pundits declaring some magic number (90% of GDP, 100%, 200% etc.) is ‘bad’ and therefore a problem with neither a measurement or theory to tell us why?

Andre July 15, 2013 at 5:59 pm

Ah yes, but he said it was too small before it failed. Specified a size and duration he thought was sufficient and made clear that what was passing didn’t meet that expectation. Important distinction.

GeorgeDoehner July 15, 2013 at 8:48 pm

Whatever number Congress proposed, he would have proposed a bigger number. I think that’s rather obvious. The game is to pick a number that could never possibly happen and then complain that *your* preferred solution was never tried. It is an old gag.

Boonton July 16, 2013 at 1:01 pm

Suppose what was adopted, though, achieved full employment? Or suppose it pushed beyond full employment into an inflatinary spiral? At that point you wouldn’t look very wise for proposing more….you’d look like the DOW 36,000 guy.

Maurice de Sully July 15, 2013 at 11:57 pm

Can you point to the specified size and duration? My recollection (of the period after the start of 2008) is more of the “too small” variety, which is a bit lacking in terms of scientific value, but I’m not as tuned in Dr. Krugman as the rest of bloglandia seems to be.

If there is a link to some specific prescriptions- particularly if he really gets going and starts breaking down spending preferences in terms of sectors- it would be much appreciated.

Andrew' July 16, 2013 at 6:17 am

Did anyone who thought it was too small not to do it at all if it’s too small?

That’s not what she said!

Boonton July 16, 2013 at 1:10 pm

Actually I think his criticism was both too small and too short. He felt the recession was going to be much longer than previous ones hence stimulus needed to be prolonged and not cut off in 2 years or so. Could you opt instead for a ‘megadose’ compressed into a very short term, like a one-time payment of $10,000 to every man and woman in the US? Possibly but I think he would have preferred something more stretched out like 1/2 payroll taxes and unemployment extended until unemployment fell. A little bit like how the Fed is supposedly committed to zero rates unless / until we go beyond 2% inflation.

Boonton July 16, 2013 at 12:34 pm

“Japan has a zombie economy due to massive debt, public and private.”

If this is the case we should see very high interest rates and high inflation. Yet we see the opposite. What you say sounds like it makes sense but it actually makes no sense at all. Why would massive debt impair your growth rate? A huge debt load would inhibit your living standard but not your income. I can imagine a lawyer who makes six figures driving a used car because he raked up massive debts and has to use his income to service them. That wouldn’t make him a bad lawyer, though. There’s no reason that wouldn’t allow him to fill up his week with billable hours.

You could argue that because Japan has massive debt, it can’t borrow for stuff it really needs. Maybe the lawyer has no car and can’t get to work because of his massive debt. OK but Japan has a lot of infrastructure and by all accounts it’s a pretty efficient place. What investment does Japan have to make and considering that investors are very happy to buy up newly issued Japanese debt why couldn’t Japan borrow it?

bob July 16, 2013 at 1:06 pm

That last point is my takeaway from Japan: If the markets are willing to buy debt from them at extremely low rates, they either don’t have too much debt, or they do, and the entire market is deluded.

If the entire market is deluded, not only we have to throw away even the loosest version of the EMH, but we need a whole lot of hubris to say that we know what is wrong, while millions of investors do not. A world where the market is that wrong for that long seems like one where the study of economics would become a waste of time.

Boonton July 16, 2013 at 1:13 pm

It’s very hard to see why the market should not buy the debt. If nothing else Japan can print yen to pay off its debt so if you buy Japanese bonds you’ll get your yen back. Greece is not allowed to buy Euros so if you buy Greek bonds you have to hope Germany will let enough Euros be printed to ensure you’re paid back.

Granted that doesn’t prevent you from taking a loss in the form of high inflation from printing a bunch of yen to pay you back. But the way to counter that is to demand higher long term interest rates in proportion to what you think is the risk of inflation.

static July 18, 2013 at 2:42 am

High interest rates and high inflation are not the only consequences of debt.

When a significant portion of government or private income is relegated to debt service, the real size of those interest payments grows large as well, even if the rates are low. 6% of the US federal budget, but 24% of the Japan federal budget.

If that money was back in the hands of the consumer or company r&d, instead of being taxed away to pay for things already bought, the economy would be more dynamic.

derek July 15, 2013 at 5:52 pm

The problem is that if the BOJ is able to inflate, there will be a massive selloff of JGB’s. All the institutional bond holders own bonds that yield something ridiculous like 15 basis points but in real terms give yield only in a deflationary environment. The question becomes how much can the BOJ buy up before everything gets detached. A 5% sell off, which is not unimaginable in this situation, would swallow what the BOJ is saying they will buy up. If you were an institutional investor, with real demands of pension liabilities for example, you have no choice but to get the necessary yield. I suspect 5% is blind hope.

Greg Ransom July 15, 2013 at 4:00 pm

Jiminy Cricket, Noah Smith has done it again, says something which isn’t ridiculous.

Edward Lambert July 15, 2013 at 4:07 pm

It’s really not a difficult issue. You only look for a long term trend that can affect demand, which in turn affects supply. And we have it… Labor share of income has been declining in Japan all these years. Labor has progressively been losing relative purchasing power.
Here is a paper by P. Agnese, 2011. “Falling labor share in Japan”.

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CCsQFjAA&url=http%3A%2F%2Fwww.iza.org%2Fconference_files%2FESSLE2010%2Fagnese_p5029.pdf&ei=G1bkUdCPEMSniAKr_oHwBg&usg=AFQjCNFSa8eNAgcQFZEqQRFjBMfCVvrbzA&sig2=sFnrhiY_25BWXnpQMhjFxA&bvm=bv.48705608,d.cGE

Yog Sothoth July 15, 2013 at 4:14 pm

The lack of inflation in the last twenty years suggests that Japan has not found a way to stimulate demand. In any model where demand shocks are a short term (Mankiw) or non-existent (RBC) friction the economy would eventually find a way to grow without inflation. Maybe reality is more like one of the old Leijonhufvud type models where the price adjustment processes in different markets are mutually frustrating result in a stable equilibrium with unemployment. That seems to be the thrust of Noah’s post. I don’t have a lot of up to date knowledge of the state of macro… Did we lose interest in these models or has their wisdom been incorporated into the profession? I can see why they might be unpopular despite offering realism. There are too many possible ways that an economy’s adjustment processes could be flawed so it’s probably difficult to come up with one base case workhorse model with an underemployment equilibrium, which the profession can adopt. I agree it’s hard to explain how depressions can last as long as Japan’s (and ours, maybe) without resorting to multiple equilibria.

Ray Lopez July 15, 2013 at 4:21 pm

Just playing Satan’s Lawyer, but Sticky Wages can indeed account for the “multiple equilibria” handwaving that Noah speaks of. Simply put, nobody in 20+ years wants to take a paycut, and the entire Japanese economy is in a giant Mexican Standoff… What is “needed” is Zimbabwe style hyperinflation to burn the barn down and rid it of the rats of bad deflation.

Bill July 15, 2013 at 5:05 pm

Or, instead of sticky wages, try sticky rice as another element–Japanese agriculutural protectionism.

Tom July 15, 2013 at 6:02 pm

In 20+ years you would have a significant turnover in employees. Many employees retire and new employees enter the labor force. Presumably new employees would be hired at lower wages. I cannot see how Sticky Wages can continue to explain Japan.

Noah Smith July 15, 2013 at 10:03 pm

Ray –

Could be, but we’ve seen lots of Japanese people taking large pay cuts.

collin July 16, 2013 at 10:52 am

Haven’t Japan wages been cut over 20 years but it is very generational? The younger generation has never been able to achieve the wages (or ‘tenure’ status) of their parent generation. So the younger generation is not as dedicated to achieve the continued growth as the older generations.

derek July 15, 2013 at 8:39 pm

But the crisis was the result of an asset inflation that crashed. The crash would have taken out the financial system and probably a good part of the business sector if it had been left to it’s own devices. Possibly a social catastrophe as well, who knows. The 20 years have been characterized by efforts to not suffer the full effects of the silliness, essentially using the accumulated resources and wealth to buy their way out of their mistakes. The extraordinarily productive export sector brought in enough surplus to add to the wealth available to waste.

Maybe the lesson from Japan is that an economy that produces a bubble large enough to threaten it’s very existence has problems that are very deep and very difficult to sort out. Industries or companies that lose the ability to do the very thing that they are paid to do go out of existence; a financial system that is incapable of pricing assets or evaluating risk needs some creative destruction. Maybe keeping banks and financial institutions alive that otherwise would be bankrupt and sold off doesn’t work.

The asian crashes in the 90’s seemed to have been recovered from.

collin July 15, 2013 at 4:31 pm

Is just a demographic bust of working depopulation? Is it just punishment for being so competitive in the 1980s that led to the population to minimize family life? Is Japan just the first of the development demographic bust?

Of course, if the wages of the developing continuing to fall, how can families afford to have more children?

msgkings July 15, 2013 at 4:44 pm

THIS. Do any models account for a system with steadily, inexorably declining and aging population?
And is this what the entire world has to look forward to in the late part of the 21st century when global population plateaus and then begins declining?

kebko July 16, 2013 at 12:04 am

Wouldn’t a demographic problem be like a supply shock, and cause inflation?

collin July 16, 2013 at 11:04 am

Depopulation and aging (especially from 45 – 60) causes deflation as people tend to buy and consume less those ages. Less young people would cause housing and rent decreases as well.

JonF July 16, 2013 at 9:14 pm

No, that’s incorrect. You are only looking at the consumption side of the equation. But when a person retires his production goes all the way to 0 while his consumption is only reduced by a minor fraction. So the net effect should be inflationary– at the very least (in principle) inflationary on labor markets. Back in the 14th century Europe lost of 1/3 of its population outright– and the result was inflation due to lost labor despite the loss of the plague victims’ demand too. Of course in the real world today outsourcing and automation can handle some of that, and in any event the mystery is why the markets do not equilibrate.

Dangerman July 16, 2013 at 3:17 pm

This.

Josh July 15, 2013 at 4:36 pm

Scott Sumner proposed money illusion as an explanation for Japan’s continued ‘demand-shortage’. It may be that extremely low/zero NGDP growth will never be enough and labor market will never adjust. There are always workers in need of a real wage cut, so if the average nominal wage does not increase over time, then there will always be problems. Firms need to be able to adjust real wages up and down without cutting nominal wages.

Andrew' July 16, 2013 at 6:24 am

My first thought was “a market for money.” Negative feedback loops aren’t going to correct themselves. Aren’t central banks always behind the curve? I don’t really believe it, but at least we could falsify it.

Mark A. Sadowski July 15, 2013 at 5:30 pm

Noah seems to be making this far more complicated than it is.

Part of the title of his post is “demand side or supply side?” The answer to the question is yes (it is both). And the the good old simple AD-AS model is indeed the way to think about it:

http://1.bp.blogspot.com/_JqNx8yXnFE8/SxlWoq_PI8I/AAAAAAAABCg/7y9VXIleCrs/s1600-h/Tabarrok-Cowen+ADAS.JPG

How do we measure aggregate demand (AD) in practical terms? With nominal GDP (NGDP) of course. The five year average growth rates of NGDP were 6.4% in 1985-90, 2.2% in 1990-95, 0.3% in 1995-2000, (-0.2%) in 2000-05 and (-0.9%) in 2005-10. So there has been a decrease in the rate of increase in AD.

How do we measure aggregate supply (AS) in practical terms? With potential real GDP (RGDP) of course. The OECD’s estimates of Japan’s potential GDP show that the five year average growth rates of potential RGDP were 3.0% in 1985-90, 2.4% in 1990-95, 1.3% in 1995-2000, 0.7% in 2000-2005 and 0.6% in 2005-10. So there has been a decrease in the rate of increase of AS.

Now, if he wants to figure out *why* the growth rates of AD and AS each have slown down, or perhaps how one has impacted the other, then that should be the subject of two, or perhaps three or four more posts.

Josh July 15, 2013 at 5:41 pm

NGDP growth rates are not quite equal to ‘demand’. In the long-run, a 5% NGDP growth rate and a 6% NGDP growth rate don’t indicate different RGDP growth rates. In the short-run we can look at changes in NGDP growth rates as indicative of demand-side changes. But, when comparing long periods of time, the analysis is much more complicated. Japan has a demand-side problem if RGDP is held back by too low NGDP, not if it simply has a lower inflation rate due to lower average NGDP growth.

Mark A. Sadowski July 15, 2013 at 7:15 pm

Josh:
“NGDP growth rates are not quite equal to ‘demand’.”

To be precise, AD is nominal GDP (NGDP) when inventory levels are static (i.e. nominal Final Sales of Domestic Product). Thus for all intents and purposes AD is in fact virtually identical to NGDP.

And if you look at the dynamic AD-AS diagram that I linked to above, and which can be found in “Modern Principles: Macroeconomics” by Tyler Cowen and Alex Tabarrok, you’ll note that the rate of change in the AD curve is equal to the sum of the inflation rate and the rate of change in RGDP, and so is precisely equal to the rate of change in NGDP.

Josh:
“In the long-run, a 5% NGDP growth rate and a 6% NGDP growth rate don’t indicate different RGDP growth rates. In the short-run we can look at changes in NGDP growth rates as indicative of demand-side changes. But, when comparing long periods of time, the analysis is much more complicated. Japan has a demand-side problem if RGDP is held back by too low NGDP, not if it simply has a lower inflation rate due to lower average NGDP growth.”

This is reflected in the dynamic AD-AS model by the difference between the short run AS (SRAS) curve and the Solow growth curve, and this is also depicted in the link above. In the short run wages and prices are sticky causing the SRAS curve to be upwardly sloped. In the long run money is neutral and wages and prices are flexible so the Solow growth curve is vertical. Thus shifts in AD influence the rate of growth of RGDP in the short run, but not in the long run.

Taken individually, inflation and short run RGDP growth are each very poor indicators of shifts in AD as changes in inflation and short run RGDP growth can also be caused by shifts in the SRAS curve. The only reliable way of determining if there has been a shift in AD is to look at AD itself, that is, to look at the rate of change in NGDP.

The 5 year average NGDP growth rates suggest that Japan has been hit by a series of negative shocks to AD since 1990. The 5 year average potential RGDP growth rates suggest that Japan has also been hit by a series of negative shocks to AS between 1990 and 2005.

Josh July 15, 2013 at 10:45 pm

I see what you are saying. But, based on your numbers, it looks like NGDP growth was pretty steady from 2000-2010. Any NGDP/demand shocks that occurred before then should have been compensated by shifts in AS over time.

TallDave July 17, 2013 at 11:31 pm

I’m confused. Did you mean it was steadily near-zero?

Amelanchier July 15, 2013 at 5:51 pm

RBC seems to be discarded too easily. This is pretty weak:

“But I don’t think Japan is living in an RBC world either. Because in an RBC world, keeping interest rates at zero for decades, and printing a bunch of money (as the Bank of Japan did in the mid-2000s), should cause inflation (without helping growth). Instead, we see persistent deflation. So an RBC model of the common type can’t be describing Japan’s world either.”

What’s been happening to the velocity of money?

Martin July 15, 2013 at 6:17 pm

“The “short run” for Japan is over and done. We are not looking at a “short-run” fluctuation caused by sticky prices.”

This seems wrong to me. The short run is not about the length of time, it’s about the type of adjustment. Time is just a proxy for this type of adjustment. The short run can be as long as you want it to be, as long as the adjustments are not made.

Why the adjustments are not made is the problem of interest, which is lost out of sight by focusing on a time period of an arbitrary length.

asdf July 15, 2013 at 8:33 pm

Exactly what is Japan supposed to demand that it doesn’t already have?

spandrell July 15, 2013 at 9:25 pm

Securitized mortgages, of course. How is Goldman Sachs supposed to make a profit if Japanese old people don’t invest their money with them?

Andrew' July 16, 2013 at 6:26 am

It’s a good question. I suspect we are at “peak stuff” and they have much smaller homes.

asdf July 16, 2013 at 9:52 am

Stuff Japan already has:

1) Excellent public infrastructure across the board

2) As “green” a power and waste management system as is reasonably possible. Everything is clean with low pollution

3) A general first world living standard with all the usual stuff

4) The ability to travel, especially on the relative cheap within the country due to trains

5) They have very little crime or disorder, no need to demand more police

6) They have some of the best electronic gadgets in the world, better then here from my time over there

7) They have a large number of entertainments

8) They have a wide variety of food options, especially consider the geographical limitations

9) They’re housing is good quality, and it can’t get any bigger due to land constrictions

10) They have an efficient and quality universal healthcare system

11) They already spend a ton on education even outside of the public sphere

12) If you’ve seen their service sector they have definitely created as many jobs as they possibly can

As Spandrell points out, besides trying to recreate the 1990 property bubble exactly what would drive growth in Japan?

I think they live in a happy and healthy country that has what it needs and lives in harmony. They could do a bit better job of bringing in the next generation but overall more is working then is broke.

Boonton July 16, 2013 at 12:12 pm

So you’re saying Japan has achieved a ‘post-scarcity economy’? If you gave 1000 random people $1000 gift cards there would be little or no change in consumption because just about everyone in Japan has just about every material thing they could want? If that was the case you would indeed see stagnation and deflation. Who would want to bother with a full time job, or getting a better job, or starting a new business in such an environment? Likewise in such an environment it would be a challenge to sell what products are produced so you’d either have to cut prices or at least find it very difficult to take price increases.

I think you overestimate just how nice things are in Japan. Per capita income and wealth is still less than it is in the US. There’s still room for living standards to improve in Japan and a will for Japanese people to enjoy higher loiving standards.

asdf July 16, 2013 at 1:55 pm

I think people in Japan have nearly all the material things they want or need. That additional consumption would not lead to a very material increase in happiness, and that many Japanese have already come to the conclusion that additional consumption is not worth the work they would have to do to get it.

There are of course positional goods to fight over, but that’s a zero sum game. What non positional goods do you think are being undersupplied in Japan, given the constrictions of space that nothing can be done about.

Boonton July 16, 2013 at 2:07 pm

Ahhhh so mass conversion to Zen Buddhism has produced a post demand economy? :)

Japan’s income per capita is $45K per person, not far from our $48K. But their poverty rate is actually kind of high, only slightly behind ours (see http://www.nytimes.com/2010/04/22/world/asia/22poverty.html?_r=0). It’s not very plausible to me to say Japan couldn’t consume more because it’s just so satisfied at the moment, unless you could say the same about Americans (which you can’t IMO).

Also keep in mind consumption isn’t just toys, TV’s and dinners out. Medical care is consumption too. I see people here claiming an aging population means lower consumption. Yes older people won’t hit the mall as much but the decline in retail consumption is almost certainly swamped by the increase in medical consumption.

asdf July 16, 2013 at 4:13 pm

Japan has universal healthcare. How much more can they consume?

We spend twice as much and have nothing to show for it.

Boonton July 16, 2013 at 4:24 pm

Well Japan spend 8.5% of GDP on health care. An aging population means more spending by that alone. But if Japan’s poverty is nearly as bad as the US’s then there’s plenty of room for non-health consumption spending to increase.

TallDave July 17, 2013 at 11:12 pm

Things Japan doesn’t have:

1) Living space
2) Cheap food
3) Cheap energy

South Korea is going to be per-capita PPP-adjusted GDP richer than Japan soon. Consider how strange that is.

They also do not have particularly good healthcare. Healthcare is tightly rationed by our standards, especially palliative and infant care (Japan is much more likely to call marginal infants stillborn) — e.g. the U.S has far more NICU per capita than other countries.

TallDave July 17, 2013 at 11:26 pm

Also, Japan is significantly poorer than we are in terms of living standards — on a PPP basis it’s more like $36K vs $49K. They’re even well behind Canada or Australia.

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita

TallDave July 17, 2013 at 11:34 pm

http://www.nytimes.com/2007/10/12/world/asia/12japan.html?pagewanted=all&_r=0
——-
Japan has traditionally been hard on welfare recipients, and experts say this city’s practices are common to many other local governments. Applicants are expected to turn to their relatives or use up their savings before getting benefits. Welfare is considered less of an entitlement than a shameful handout.

“Local governments tend to believe that using taxpayer money to help people in need is doing a disservice to citizens,” said Hiroshi Sugimura, a professor specializing in welfare at Hosei University in Tokyo. “To them, those in need are not citizens. Only those who pay taxes are citizens.”

Toshihiko Misaki, head of the city’s welfare section, did not refer to the three deaths as from starvation, but called them “solitary.” He defended the system.

Nick July 15, 2013 at 9:31 pm

A policy process mechanism might be overlooked. Easier money isnt just a way to boost short term demand during a demand shock. Its also a goood substitute for loads of bad fiscal policies that governments use when there is demand shortfall but have bad longterm effects.

observer July 16, 2013 at 2:09 am

“But I don’t think Japan is living in an RBC world either. Because in an RBC world, keeping interest rates at zero for decades, and printing a bunch of money (as the Bank of Japan did in the mid-2000s), should cause inflation (without helping growth). Instead, we see persistent deflation. So an RBC model of the common type can’t be describing Japan’s world either.”

OMG.

RBC does not speak to the nominal side at all. In a pure RBC, you can justify ANY nominal interest rate as an equilibrium, as long as the Fisher equation holds. Proof: Let the real interest rate be 1%, and let the public believe inflation will be -1%. Let the central bank choose a nominal interest rate of 0%. Let everybody cut their nominal prices by 1% per year. Is this a rational expectations equilibrium? It is! Is money held? It is, it earns the same return as the real asset.

Period.

So much for Noah’s “excellent” post.

Hazel Meade July 16, 2013 at 11:27 am

Might Japan’s aging population have a lot to do with this? Old people don’t produce as much (supply side) and they also don’t consume as much (demand side).

Boonton July 16, 2013 at 12:16 pm

“And whatever world Japan is living in may have multiple equilibria. ”

Isn’t this a feature of hard-core Keynesian economics? Not only is a recession a temporary deviation from a long term equilibrium but it’s perfectly possible for an economy to have multiple equilibria far below the production possibilities frontier resulting in a state of what appears to be a long-term depression/recession?

“This has implications for policy. It means that we can’t expect the “first arrow” of Abenomics – quantitative easing – to boost the real economy through the kind of channel described by a New Keynesian or AD-AS model. It might do so through some other channel, but how exactly that will work is not clear.”

So if you think you have a leak somewhere you should turn the water on and see where it goes. You’ll never find a leaky pipe in a house with the main water shut off. If this is the case ramp up money printing to the max until you start to see some signs of actual inflation. It’s got to go somewhere after all.

Floccina July 16, 2013 at 3:23 pm

What if people are continuing to deleverage long term due to so change or perceived change, one real change might be the rise in average age, then doesn’t the central bank need to keep up long term?

Frederick Harrison July 17, 2013 at 7:28 am

These politicians in Japan and in many other countries lack the competence to deal with the many problems arising from the economic crisis, yet they pigheadedly plough on with their failed policies. Perhaps they need advice from professional economic crisis specialists like the Orlando Bisegna Index, specialists in the economic crisis, have helped various counties with debt problems, business failures and unemployment.

Bill Cecil July 17, 2013 at 4:34 pm

The Japanese Ministry of Internal Affairs and Communications Statistical Survey Department reports that population growth has been less than one percent since 1977 and negative since 2009. They have also projected population growth to be negative through 2110, dropping from an estimate of 127 million in 2012 to 124 million by 2020 and to 43 million by 2110. Obvious implications for capacity planning and demand.

TallDave July 17, 2013 at 11:19 pm

Well, they’ve had tight monetary policy — the markets are practically shrieking it. OK, they have other challenges, but NGDPLT would have helped them work through those with less pain.

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