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Identifying Aggregate Demand and Aggregate Supply Components of Inflation Rate: A Structural Vector Autoregression Analysis for Japan

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  • Mio, Hitoshi

    (Bank of Japan)

Abstract

I estimate a bivariate output-price structural vector autoregression (VAR) model for Japan to decompose inflation rate time-series into two components explained by aggregate demand (AD) and aggregate supply (AS) shocks. For the model fs identifying restriction, I assume that the long- run elasticity of output with respect to permanent changes in price due to AD shocks is zero; i.e., an AD shock has no long-run impact on the level of output. Dynamic properties of the estimated model are shown to be generally consistent with the predictions of the conventional AS-AD framework. The main features of the historical decomposition are the following: (1) the inflation rate explained by the AD shock shows a procyclical swing since 1970; (2) the inflation rate explained by the AS shock temporarily spikes during the two oil crises and experiences a large countercyclical swing in the 1990s; and (3) the coincidence of large and negative AS and AD shocks explains the combination of price stability and output stagnation during two recessions in the 1990s. These results are qualitatively robust to the sectoral shocks, alternative choices for the price variable, and assumptions for the lag length of VAR and the long-run elasticity of output with respect to permanent changes in price due to AD shocks. However, the bivariate approach does not allow the identification of more than three types of shocks with different dynaic effects on output and price. It might be necessary to expand the model to deal with this limitation.

Suggested Citation

  • Mio, Hitoshi, 2002. "Identifying Aggregate Demand and Aggregate Supply Components of Inflation Rate: A Structural Vector Autoregression Analysis for Japan," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 20(1), pages 33-56, January.
  • Handle: RePEc:ime:imemes:v:20:y:2002:i:1:p:33-56
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    References listed on IDEAS

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    1. Christine Gartner & Gert Wehinger, 1998. "Core Inflation in Selected European Union Countries," Working Papers 33, Oesterreichische Nationalbank (Austrian Central Bank).
    2. Luis J. Álvarez & María de los Llanos Matea, 1999. "Underlying Inflation Measures in Spain," Working Papers 9911, Banco de España;Working Papers Homepage.
    3. Ben S. Bernanke & Ilian Mihov, 1998. "Measuring Monetary Policy," The Quarterly Journal of Economics, Oxford University Press, vol. 113(3), pages 869-902.
    4. Laurence Ball & N. Gregory Mankiw, 1995. "Relative-Price Changes as Aggregate Supply Shocks," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 161-193.
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    Cited by:

    1. Ogawa, Eiji & Iwatsubo, Kentaro, 2009. "External adjustments and coordinated exchange rate policy in Asia," Journal of Asian Economics, Elsevier, vol. 20(3), pages 225-239, May.
    2. Hondroyiannis, George & Papapetrou, Evangelia, 2006. "Stock returns and inflation in Greece: A Markov switching approach," Review of Financial Economics, Elsevier, vol. 15(1), pages 76-94.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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