What Caused the Pandemic-Era Inflation?: Application of the Bernanke-Blanchard Model to Japan

Many countries have experienced high inflation since the COVID-19 pandemic. Japan is no exception, albeit lower levels than those of other countries. This paper analyzes the direct and indirect effects of product-market and labor-market shocks on prices and nominal wages using the model proposed by Bernanke and Blanchard (2023). With minor modifications to incorporate the dual structure of the Japanese labor market, the model achieved a good fit to actual Japanese data. The main findings are as follows. First, the high inflation that Japan has experienced in the wake of the pandemic can be explained mostly by product-market specific shocks such as energy and food price spikes, but not by labor market tightness. This result is similar to the U.S. results presented in the Bernanke-Blanchard paper, which is somewhat surprising given the differences between Japan and the U.S. in labor market structure and firms' price- and wage-setting behavior. Second, Japan's low inflation relative to the U.S. during this period can be explained by a difference in the initial conditions of the underlying inflation trend before the pandemic and a difference in the degree of labor market tightness. Lastly, the model suggests that the impact on inflation of changes in labor market tightness was weaker in Japan.