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Preventing deflation: lessons from Japan's experience in the 1990s

Author

Listed:
  • Alan G. Ahearne
  • Joseph E. Gagnon
  • Jane Haltmaier
  • Steve Kamin ... [et al.].

Abstract

This paper examines Japan's experience in the first half of the 1990s to shed some light on several issues that arise as inflation declines toward zero. Is it possible to recognize when an economy is moving into a phase of sustained deflation? How quickly should monetary policy respond to sharp declines in inflation? Are there factors that inhibit the monetary transmission mechanism as interest rates approach zero? What is the role for fiscal policy in warding off a deflationary episode? We conclude that Japan's sustained deflationary slump was very much unanticipated by Japanese policymakers and observers alike, and that this was a key factor in the authorities' failure to provide sufficient stimulus to maintain growth and positive inflation. Once inflation turned negative and short-term interest rates approached the zero-lower-bound, it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s, the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations, we draw the general lesson from Japan's experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus, both monetary and fiscal, should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.

Suggested Citation

  • Alan G. Ahearne & Joseph E. Gagnon & Jane Haltmaier & Steve Kamin ... [et al.]., 2002. "Preventing deflation: lessons from Japan's experience in the 1990s," International Finance Discussion Papers 729, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:729
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    References listed on IDEAS

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    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. "There Is No Deflation Threat In Europe" - Jean Claude Trichet - Oh Really!
      by Edward Hugh in global economy matters on 2009-03-02 18:50:00
    2. “There Is No Deflation Threat In Europe” - Jean Claude Trichet - Oh Really!
      by ? in A Fistful Of Euros on 2009-03-02 05:11:14
    3. "There Is No Deflation Threat In Europe" - Jean Claude Trichet - Oh Really!
      by ? in Bonobo Land on 2009-03-02 18:52:00
    4. "There Is No Deflation Threat In Europe" - Jean Claude Trichet - Oh Really!
      by ? in Euro Watch on 2009-03-02 18:50:00

    Citations

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    Cited by:

    1. Eckhard Hein & Thorsten Schulten & Achim Truger, 2004. "Wage trends and deflation risks in Germany and Europe," Macroeconomics 0412008, EconWPA.
    2. Buiter, Willem H., 2003. "Deflation: Prevention and Cure," CEPR Discussion Papers 3869, C.E.P.R. Discussion Papers.
    3. Hans Genberg, 2005. "External Shocks, Transmission Mechanisms and Deflation in Asia," Working Papers 062005, Hong Kong Institute for Monetary Research.
    4. Coenen, Gunter & Wieland, Volker, 2003. "The zero-interest-rate bound and the role of the exchange rate for monetary policy in Japan," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1071-1101, July.
    5. Shigeyoshi Miyagawa & Yoji Morita & Yoshitaka Sawada, 2007. "The Role of Central Bank in the Recession in the Case of Japan's Recession," Discussion Papers 17, Aboa Centre for Economics.
    6. Takatoshi Ito & Frederic S. Mishkin, 2006. "Two Decades of Japanese Monetary Policy and the Deflation Problem," NBER Chapters,in: Monetary Policy with Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 131-202 National Bureau of Economic Research, Inc.
    7. Grunspan, T., 2005. "The Fed and the Question of Financial Stability: An Empirical Investigation," Working papers 134, Banque de France.
    8. Jess Diamond & Kota Watanabe & Tsutomu Watanabe, 2016. "The Formation of Consumer Inflation Expectations:Evidence From Japan's Deflation Experience," UTokyo Price Project Working Paper Series 067, University of Tokyo, Graduate School of Economics.
    9. Ippei Fujiwara, Naoko Hara, Naohisa Hirakata, Takeshi Kimura, and Shinichiro Watanabe, 2007. "Japanese Monetary Policy during the Collapse of the Bubble Economy: A View of Policymaking under Uncertainty," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 25(2), pages 89-128, November.
    10. Felicity C Barker & Robert A Buckle & Robert W St Clair, 2008. "Roles of Fiscal Policy in New Zealand," Treasury Working Paper Series 08/02, New Zealand Treasury.
    11. Frederic S. Mishkin, 2007. "Housing and the monetary transmission mechanism," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 359-413.
    12. Maurice Obstfeld, 2009. "Time of Troubles: The Yen and Japan's Economy, 1985-2008," NBER Working Papers 14816, National Bureau of Economic Research, Inc.
    13. Orphanides, Athanasios, 2004. "Monetary policy in deflation: the liquidity trap in history and practice," The North American Journal of Economics and Finance, Elsevier, vol. 15(1), pages 101-124, March.
    14. Daiji Kawaguchi & Fumio Ohtake, 2007. "Testing the Morale Theory of Nominal Wage Rigidity," ILR Review, Cornell University, ILR School, vol. 61(1), pages 59-74, October.
    15. Ito, Takatoshi, 2009. "Fire, flood, and lifeboats: policy responses to the global crisis of 2007-09," Proceedings, Federal Reserve Bank of San Francisco, issue Oct, pages 207-249.
    16. Bank for International Settlements, 2010. "The international financial crisis and policy challenges in Asia and the Pacific," BIS Papers, Bank for International Settlements, number 52.
    17. Corneil, Bruce L. & McNamara, Sue, 2010. "Lessons and consequences of the evolving 2007-? Credit Crunch," MPRA Paper 35912, University Library of Munich, Germany.
    18. Daniel Leigh, 2009. "Monetary Policy and the Lost Decade; Lessons from Japan," IMF Working Papers 09/232, International Monetary Fund.
    19. Mark R. Stone, 2003. "Greater Monetary Policy Transparency for the G3; Lessons From Full-Fledged Inflation Targeters," IMF Working Papers 03/218, International Monetary Fund.
    20. Jess Diamond & Kota Watanabe & Tsutomu Watanabe, 2016. "The Formation of Consumer Inflation Expectations: New Evidence From Japan's Deflation Experience," CARF F-Series CARF-F-388, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

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