Deflationary Expectations and Real Cost of Capital -Micro-level Estimates of Investment Function in the 1990s(in Japanese)

The Japanese economy in the 1990s experienced a substantial decrease in the nominal interest rate. The positive effect on the business investment, however, should have been canceled out, since deflationary expectations raised the real cost of capital. In this study, we address this unexplored issue by taking advantage of firm-level micro data. First, we calculate firm-level real cost of capital in the 1990s. Our estimates demonstrate that the speed of reduction in the real cost of capital was slower than that of the nominal interest rate in the first half. Moreover, the real capital cost leveled off or even increased in the second half due to deflationary expectations. Second, we estimate firm-level investment function using the estimated real cost of capital. We obtain the result that change in the real cost of capital is associated negatively with capital formations with an elasticity of - 0.1 to - 0.2. Our empirical findings recommend that monetary authorities raise inflationary expectations so that a lower real cost of capital stimulates business investment.