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Unformatted text preview: food, CDs, electronics, and even machinery, have become contestable, due to potential supply from China. The direct share of imports is thus argued to underestimate the impact of globalisation on the Japanese prices. Relative prices are certainly affected by innovation and globalisation, but it does not follow that the general price level, such as that measured by the CPI, should follow the trend of a small category of goods and services. We expect that general price inflation is a monetary phenomenon, rather than the accumulation of relative prices changes. 2.2 Cost of deflation In the case of Japan, unlike the US, disinflation and eventual deflation were the result of recession (a shift in the aggregate demand curve) rather than output expansion (a shift of the aggregate supply curve). In order to see the relationships between inflation and growth, and between inflation and unemployment, Phillips curve figures can be used. Figure 2 shows the relationship between the rate of CPI inflation and GDP growth (both measured as the four-quarter-ended percentage change). The figure shows a non-linear, although generally positive, relationship between the two variables: namely, lower inflation is associated with lower growth, suggesting that demand shocks are more dominant than supply shocks. However, the relationship is less robust if the sample is limited to the stagnation period (19932004). Figure 3 shows the traditional Phillips curve relationship between the inflation rate and the unemployment rate. It used to be the case in Japan, say in the 1950s and 1960s, that the Phillips curve was more or less vertical (that is, there was little variation in the unemployment rate). This is no longer true. A downward-sloping curve, with a strong nonlinearity around 2 per cent inflation, can now be observed. The kink at around 2 per cent seems consistent with the predictions of Akerlof, Dickens and Perry (1996). Although the long-run Phillips curve is more or less vertical above the 2 per cent level of inflation, it is reasonably flat below the 2 per cent level. Akerlof, Dickens and Perry attribute such a result to the downward rigidity of nominal wages, providing evidence in support of this proposition. At a very low inflation rate, the adjustment of relative wages between different sectors becomes difficult, thereby increasing unemployment. However, the extent of wage rigidity is smaller in Japan, because a substantial part (typically from two- to five-months equivalent) of annual earnings are paid in Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting? 227 Figure 2: Growth Rate versus Inflation Rate
4 2 CPI inflation rate per cent 0 -2 -4 -4 -2 0 2 4 Growth rate per cent 6 8 Figure 3: Japan Phillips Curve
30 20 CPI inflation rate per cent 10 0 -10 0 1 2 3 4 Unemployment rate per cent
19751981 19821992 19932004 5 6 Note: Inflation rates are calculated as the change in the CPI from the same quarter of the year t-1, adjusted for VAT rate changes, and the unemployment rate is all ages, national average. 228 Takatoshi Ito the form of bonuses for regular workers (not only executives, but also rank and file employees), and bonuses respond quite flexibly to company performance. Kuroda and Yamamoto (2003a, 2003b), using Japanese longitudinal data from 1993 to 1998, argued that the impact of wage rigidity on unemployment is quite small in Japan, at least among regular workers. Although downward nominal wage rigidity does exist in Japan, it is most prevalent among hourly-wage, part-time female employees, and is of limited importance for the regular monthly salaries and annual earnings of full-time employees.11 Kuroda and Yamamoto (2003c) simulated the impact of downward rigidity on the male unemployment rate. Using the estimated rigidity for the full-time male workers (which is smaller than for other type of workers) from their previous studies, they fit the data to the Akerlof et al model. The simulation showed that downward rigidity would raise the unemployment rate by as much as 1.8 percentage points under the baseline parameters. Downward wage rigidity does not cause unemployment as long as the inflation rate is approximately 2.4 per cent or higher, whereas rigidity effects tend to increase gradually as the inflation rate falls below 2.4 per cent. This is consistent with Akerlof et al (1996). One of Kuroda and Yamamotos more interesting conclusions is that when inflation is below approximately 1 per cent, the marginal increase in unemployment attributable to downward rigidity becomes small, since bonus adjustments and extensive wage cuts would be triggered at that point. However, the unemployment rate rose to 5.3 per cent in 2003, which was five years after their data set stopped. It would be interesting to see whether the same conclusion holds at the right-end tail of the Phillips curve. Taking Kuroda and Yamamoto (2000a, 2000b, 2000c) literally, the cost of deflation was not evident through the wage rigidity channel in J...
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This note was uploaded on 05/12/2010 for the course COMMERCE finc at University of Sydney.