Abstract
A sustained decline in fertility rates underlies a rapid aging and decline of Japan's population. This will have profound social and economic implications. The paper illustrates the difficult situation facing Japanese fiscal policy in the years ahead. The findings of this paper indicate that there may be a role for foreign exchange interventions in providing stimulus at the current conjuncture. Deposit insurance reform is a central element in the government strategy to strengthen the Japanese banking system. The unemployment-deflation puzzle in Japan has been explained.
V. Japan: The Unemployment Deflation Puzzle
by Takashi Nagaoka
A. Introduction
1. Since the middle of 1997, the Japanese economy has experienced a sharp widening of the output gap and a steep increase in unemployment (Table V.I). The IMF’s estimate of the output gap reached 4½ percent of GDP by 1999, while the unemployment rate reached a record high of just below 5 percent in the summer of 1999.
Selected Indicators
Selected Indicators
| 1991-1995 average | 1995 | 1996 | 1997 | 1998 | 1999 | |
|---|---|---|---|---|---|---|
| (Percent change from previous period, unless otherwise indicated) | ||||||
| Real GDP | 1.4 | 1.5 | 5.0 | 1.6 | -2.5 | 0.2 |
| Output gap (in percent of potential GDP) | 0.3 | -1.7 | 1.3 | 0.9 | -3.4 | -4.5 |
| Unemployment rate (in percent) | 2.6 | 3.1 | 3.3 | 3.4 | 4.1 | 4.7 |
| GDP deflator | 0.9 | -0.6 | -1.4 | 0.3 | 0.3 | -0.9 |
| CPI | 1.4 | -0.1 | 0.1 | 1.7 | 0.6 | -0.3 |
Selected Indicators
| 1991-1995 average | 1995 | 1996 | 1997 | 1998 | 1999 | |
|---|---|---|---|---|---|---|
| (Percent change from previous period, unless otherwise indicated) | ||||||
| Real GDP | 1.4 | 1.5 | 5.0 | 1.6 | -2.5 | 0.2 |
| Output gap (in percent of potential GDP) | 0.3 | -1.7 | 1.3 | 0.9 | -3.4 | -4.5 |
| Unemployment rate (in percent) | 2.6 | 3.1 | 3.3 | 3.4 | 4.1 | 4.7 |
| GDP deflator | 0.9 | -0.6 | -1.4 | 0.3 | 0.3 | -0.9 |
| CPI | 1.4 | -0.1 | 0.1 | 1.7 | 0.6 | -0.3 |
2. Prices, however, have remained broadly stable since 1998, notwithstanding widespread concerns about the potential for a deflationary spiral (Figure V.I). Although the various price indicators have followed somewhat different paths over the last decade, the core CPI (which excludes fresh food) has shown little change since mid-1998, despite the deterioration of output and employment indicators (Figure V.2).1 This recent behavior seems at variance with earlier experience when the core CPI moved broadly in line with both the output gap and the unemployment rate, as also suggested by a (linear) Phillips curve. This observation raises the question of why prices have not gone down further.
Japan: Price Developments 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; WEFA; and staff estimates.1/ Not adjusted for changes in consumption tax rate and medical insurance systemJapan: Price Developments 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; WEFA; and staff estimates.1/ Not adjusted for changes in consumption tax rate and medical insurance systemJapan: Price Developments 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; WEFA; and staff estimates.1/ Not adjusted for changes in consumption tax rate and medical insurance system
Japan: Development of Output Gap, Unemployment, and Core CPI 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; and staff estimates.1/ Seasonally adjusted.2/ Adjusted for introduction of consumption tax and repeal of excises in Apri! 1989, increase in consumption tax rate in April 1997, and medical insurance system reform in September 1997.Japan: Development of Output Gap, Unemployment, and Core CPI 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; and staff estimates.1/ Seasonally adjusted.2/ Adjusted for introduction of consumption tax and repeal of excises in Apri! 1989, increase in consumption tax rate in April 1997, and medical insurance system reform in September 1997.Japan: Development of Output Gap, Unemployment, and Core CPI 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; and staff estimates.1/ Seasonally adjusted.2/ Adjusted for introduction of consumption tax and repeal of excises in Apri! 1989, increase in consumption tax rate in April 1997, and medical insurance system reform in September 1997.3. There are two possible arguments that could dismiss this question outright. The first is that the Phillips curve could in fact be nonlinear.2 If the relationship between the output gap (or the unemployment rate) and price changes is indeed convex, then there is no puzzle between a broadly stable inflation rate (near zero) despite the increase in unemployment or the output gap in recent years. Another possibility is that the output gap is much smaller than estimated by the staff and some other observers (see Hayakawa and Maeda (2000) for a view that the output gap in Japan at present is smaller than generally believed). In this case, price changes in recent years might in fact be consistent with past relationships between the gap and inflation.
4. While recognizing these possibilities, there could also be other factors that help explain recent inflation performance, and that do not depend on a nonlinear Philips curve or mismeasurement of the output gap. In this vein, this chapter discusses a number of possible causes for the failure of prices to decline more significantly in recent years. The next section looks at the issue of CPI measurement bias, while subsequent sections discuss downward rigidity of nominal wages, pricing behavior of companies, and perceptions about price developments in the private sector. A final section summarizes the main conclusions.
B. Measurement Bias in the CPI—Not A Major Cause
5. As in other countries, the CPI in Japan is compiled using the Laspeyres method, which fixes the basket of items in the base year.3 Subsequent shifts in the actual mix of items, as consumers react to changes in relative prices by shifting their consumption basket to lower cost items, generate an upward bias in the measure of the increase in the cost of living. Consumption of items with quality changes and newly introduced products (which may not be captured in consumer price surveys) can also produce bias in measured inflation. A further potential source of error relates to sampling problems, in particular, failure to fully reflect seasonal discount pricing and increasing use of new retail outlets offering lower prices (including the internet).
6. Statisticians make efforts to try to reduce the degree of measurement bias in the CPI. Possible distortions from shifts in the composition of the consumption basket are mitigated by base revisions every five years, and continuing efforts to ensure that vendor samples are representative of the evolving population. Most OECD countries (including Japan) try to make allowance for quality improvements through a combination of overlap methods (where price differences between old and replacement items are considered to reflect quality differences, based on the assumption that the price per unit of quality is identical for both the old and replacement item) and direct comparison methods (where no quality difference is assumed except for quantity metric), rather than the increasingly advocated hedonic approaches (see Greenlees (1999) for quality adjustment methods).4 Although the usefulness of the hedonic approach for quality adjustment has been widely acknowledged, the approach has limitations in that it requires too much time and information to be used for the construction of monthly indicators. Nevertheless, for product categories with rapid technological innovations and short product life cycles (such as personal computers), the conventional adjustment methods would not fully capture the impact of quality changes or the introduction of new products, thus leaving some degree of upward bias in measured CPI inflation.
7. Quantitative estimation of the upward bias in the Japanese CPI series, based on the assumptions of Shiratsuka (1999), suggests that the total measurement bias could be around 0.9 percentage points (the estimates range from 0.35 to 2.00 percentage points, depending on assumptions).5 This result compares with the estimated upward bias in the United States, which lies around 1.1 percentage points (with a slightly narrower range).6
8. In the recent deflationary environment, a bias of such magnitude may have a substantial impact on correctly gauging price development. However, it does not appear to be a strong candidate to explain the change in the traditional price-unemployment relationship in the late 1990s, since the explanatory factors underlying the bias have not changed drastically over time, let alone jumped discontinuously since 1998.
C. Prices and Unemployment
9. Figure V.3 shows the historical relationship between the core CPI and unemployment as a scatter diagram from the first quarter of 1983 to the end of 1999. The superimposed trend line fits the data quite well through 1996. However, this historical relationship seems to have broken down since 1998.
Japan: Unemployment and Core CPI 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei felt com; and staff estimates.1/ Seasonally adjusted. Core CPI is adjusted for introduction of consumption tax and repeal of excises in April 1989 increase in consumption tax rate in April 1997. and medical insurance system reform in September 1997.Japan: Unemployment and Core CPI 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei felt com; and staff estimates.1/ Seasonally adjusted. Core CPI is adjusted for introduction of consumption tax and repeal of excises in April 1989 increase in consumption tax rate in April 1997. and medical insurance system reform in September 1997.Japan: Unemployment and Core CPI 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei felt com; and staff estimates.1/ Seasonally adjusted. Core CPI is adjusted for introduction of consumption tax and repeal of excises in April 1989 increase in consumption tax rate in April 1997. and medical insurance system reform in September 1997.10. To reinforce the notion, a reduced-form short-run Phillips curve is estimated, using data from the first quarter of 1983 to the fourth quarter 1996. The equation is specified as:
ΔPt/Pt - 1 = α + βΔPt - 1/Pt - 2 + γUt + εt,
where ΔPt/Pt-1 is the quarterly percentage change in the core CPI and U is the unemployment rate.7 The result is as shown in Table V.2.
Estimate of Reduced Form Phillips Curve, 1983Q1–1999Q4
Estimate of Reduced Form Phillips Curve, 1983Q1–1999Q4
| Constant | Independent Variables Δ Pt - i/Pt - 2 | Ut | |
|---|---|---|---|
| Coefficient | 1.184 | 0.2781 | -0.3662 |
| t-statistics | (-4.078) | (-2.189) | (-3.677) |
| R2 | 0.477701 | ||
| Adjusted R2 | 0.457992 | ||
| DW statistics | 1.83 | ||
| Regression by PcGive 9.0 for Windows. | |||
Estimate of Reduced Form Phillips Curve, 1983Q1–1999Q4
| Constant | Independent Variables Δ Pt - i/Pt - 2 | Ut | |
|---|---|---|---|
| Coefficient | 1.184 | 0.2781 | -0.3662 |
| t-statistics | (-4.078) | (-2.189) | (-3.677) |
| R2 | 0.477701 | ||
| Adjusted R2 | 0.457992 | ||
| DW statistics | 1.83 | ||
| Regression by PcGive 9.0 for Windows. | |||
11. Next, a one-step ahead forecast is conducted on this specification for the twelve quarters through end-1999 to compare the traditional relationship and the actual core CPI movement (Figure V.4), The sizable discrepancies for multiple quarters in 1998 and 1999 support the view that there have been successive departures of the core CPI from the historical relationship through 1996, on the assumption of a linear Phillips curve.
Japan: Results of the One-Step Forecast Test 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: Staff estimates.1/ 1-slep forecast test conducted using PcGive 9.0 for Windows, for 1997Q1 through 1999Q4. using the specification derived from data sets over 1983Q1 to 1996Q4.Japan: Results of the One-Step Forecast Test 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: Staff estimates.1/ 1-slep forecast test conducted using PcGive 9.0 for Windows, for 1997Q1 through 1999Q4. using the specification derived from data sets over 1983Q1 to 1996Q4.Japan: Results of the One-Step Forecast Test 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: Staff estimates.1/ 1-slep forecast test conducted using PcGive 9.0 for Windows, for 1997Q1 through 1999Q4. using the specification derived from data sets over 1983Q1 to 1996Q4.D. Downward Rigidity of Wages
12. A possible reason for downward price rigidity could be the downward rigidity of nominal wages. Nominal wage rigidity could be due to features of multi-year wage contracts that do not permit renegotiations when the economy experiences a downturn. The possibility that wage contracts in different sectors are agreed on overlapping schedules may inhibit firms from reducing nominal wages at renegotiations for fear of losing capable workers. There may also be greater psychological resistance to nominal wage cuts as opposed to erosion of real wages through price increases.
13. Downward wage rigidity, however, appears to be less relevant in Japan than elsewhere. Indeed, a stylized fact about the Japanese economy is that Japanese firms in general turn to nominal wage adjustments rather than labor shedding for flexibility in reducing labor costs during downturns. That is, a cooperative labor-management relationship since the mid-1950s has allowed firms to accommodate cyclical fluctuations in demand mainly by adjusting nominal wages by varying overtime and bonus payments. The practice of annual base salary revisions through synchronized labor-management negotiations across industries (Shunto) has also diminished the possible effects of long intervals between wage negotiations and overlap of such intervals among sectors.
14. Nominal wage developments since 1998 are in fact consistent with considerable downward flexibility (Figure V.5).8 Total cash earnings as a whole fell by 1.3 percent on a year-on-year basis in both 1998 and 1999. Bonus payments have been the primary source of the downward flexibility, contributing over 1 percentage point of the decline in total cash earnings in both years.9 Overtime earnings have also contributed to downward flexibility through adjustment of working hours. A small contribution to downward flexibility is also evident in the behavior of scheduled earnings in the last two years, as the number of hours worked has declined, offsetting the steady increase in hourly earnings. While some noncyclical factors such as the spread of a 2-day weekend system have reduced the number of scheduled working hours, most of the reduction in overall hours worked is explained by lower overtime.
Japan: Development of Nominal Cash Earnings 1/2/3/4/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; Ministry of Labor; and staff estimates.1/ Not seasonally adjusted.2/ Nominal cash earnings and hours worked per regular employee (for establishment with 5 employees or more) are used as the indicators for nominal wages and hours worked, respectively.3/ Total earnings comprises contractual earnings and non-contractual earnings (bonuses), of which contractual earnings can be divided into scheduled earnings and non-scheduled earnings (overtime earnings).4/ Regular employees are those who are either a) employed without a term or with a term exceeding one month, or b) employed daily or with a term of less than one month, who have been employed for more than 18 days in each of the preceding two months. Thus, the data include those for part-time employees, i.e., regular employees who have either a) shorter scheduled daily work time than general employees or b) identical scheduled daily work time but less scheduled weekly work day than general employees.Japan: Development of Nominal Cash Earnings 1/2/3/4/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; Ministry of Labor; and staff estimates.1/ Not seasonally adjusted.2/ Nominal cash earnings and hours worked per regular employee (for establishment with 5 employees or more) are used as the indicators for nominal wages and hours worked, respectively.3/ Total earnings comprises contractual earnings and non-contractual earnings (bonuses), of which contractual earnings can be divided into scheduled earnings and non-scheduled earnings (overtime earnings).4/ Regular employees are those who are either a) employed without a term or with a term exceeding one month, or b) employed daily or with a term of less than one month, who have been employed for more than 18 days in each of the preceding two months. Thus, the data include those for part-time employees, i.e., regular employees who have either a) shorter scheduled daily work time than general employees or b) identical scheduled daily work time but less scheduled weekly work day than general employees.Japan: Development of Nominal Cash Earnings 1/2/3/4/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Nikkei Telecom; Ministry of Labor; and staff estimates.1/ Not seasonally adjusted.2/ Nominal cash earnings and hours worked per regular employee (for establishment with 5 employees or more) are used as the indicators for nominal wages and hours worked, respectively.3/ Total earnings comprises contractual earnings and non-contractual earnings (bonuses), of which contractual earnings can be divided into scheduled earnings and non-scheduled earnings (overtime earnings).4/ Regular employees are those who are either a) employed without a term or with a term exceeding one month, or b) employed daily or with a term of less than one month, who have been employed for more than 18 days in each of the preceding two months. Thus, the data include those for part-time employees, i.e., regular employees who have either a) shorter scheduled daily work time than general employees or b) identical scheduled daily work time but less scheduled weekly work day than general employees.15. In fact, scatter diagrams of year-on-year changes of cash earnings against the unemployment rate appear to suggest a linear relationship between the two variables, consistent with a linear wage-unemployment Phillips curve (Figure V.6). The diagrams suggest that firms have responded to the changes in economic conditions first by controlling nominal wages, and then by turning to employment control, once wage increases have been brought close to zero. Subsequent upturns in the business environment appear to have boosted wages rather than employment. An econometric study by Kimura (1999) supports this analysis, finding that the hypothesis of downward earnings rigidity, which could not be rejected using data set through 1997, could be rejected when the data are extended through 1998.
Japan: Unemployment and Nominal Wages
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources; Nikkei Telecom; and staff estimates.1/ Seasonally adjusted.Japan: Unemployment and Nominal Wages
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources; Nikkei Telecom; and staff estimates.1/ Seasonally adjusted.Japan: Unemployment and Nominal Wages
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources; Nikkei Telecom; and staff estimates.1/ Seasonally adjusted.16. Moreover, ongoing structural changes in the labor market have tended to increase the degree of wage flexibility over time (Tachibanaki, Fujiki and Nakada (2000)). The increasing share of part-time workers may provide a partial explanation of the decline in the number of hours worked and the slowdown of scheduled hourly earnings growth. Moreover, the fact that female workers have constituted most of the increase suggests further flexibility in nominal wages, as female part-time workers wages have structurally remained at low levels (Figure V.7).10 A study by the Ministry of Labor suggests that the increase in the share of part-time employees has reduced scheduled earnings for regular employees (including part-time employees) by about ½ percent per year since 1996.
Japan: Part-Time Employment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Management and Coordination Agency; Ministry of Labor; and staff estimates.Japan: Part-Time Employment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Management and Coordination Agency; Ministry of Labor; and staff estimates.Japan: Part-Time Employment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Management and Coordination Agency; Ministry of Labor; and staff estimates.17. Corporate restructuring, and the associated shift away from the traditional lifetime employment system, together with other structural shifts towards the “knowledge-based” economy, are also likely to have raised the natural rate of unemployment, and so increased the amount of inflation expected for any particular degree of economic slack. EPA (1999) suggests that job mismatches have become more prevalent for older age groups, indicating a higher degree of involuntary unemployment for older workers (Figure V.8), while younger workers appear to be growing more tolerant of voluntary unemployment. Impediments to labor mobility—in particular lack of private portable pension schemes—may also have raised the noncyclical component of unemployment in recent years, as structural changes in the economy have accelerated.
Japan: Composition of Unemployment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Management and Coordination Agency; and CEIC Database.Japan: Composition of Unemployment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Management and Coordination Agency; and CEIC Database.Japan: Composition of Unemployment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Management and Coordination Agency; and CEIC Database.18. Rising structural unemployment is also apparent from a chart of vacancy rates and the unemployment rate during the 1990s. The top panel of Figure V.9 shows the Beveridge curve (which compares the vacancy rate and the unemployment rate excluding the self-employed) over the last fifteen years. In the figure, data points from end-1994 to mid-1997 generally move in the direction along the 45-degree line, suggesting a rising unemployment rate in an environment of expanding job openings. Such moves imply increases in the structural/frictional unemployment rate. An estimate of structural/ factional unemployment by the Ministry of Labor (MOL), reproduced in Figure V.9 (bottom panel), shows a rising trend since the mid-1990s.
Japan: Development of Structural Unemployment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: Ministry of Labor; Management and Coordination Agency; and staff estimates.Japan: Development of Structural Unemployment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: Ministry of Labor; Management and Coordination Agency; and staff estimates.Japan: Development of Structural Unemployment
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: Ministry of Labor; Management and Coordination Agency; and staff estimates.E. Pricing Behavior of Companies
19. Firms’ efforts to raise gross margins provide another possible explanation of why prices have not declined more significantly in Japan in recent years. Some observers have suggested that there has been a shift in Japanese firms’ pricing behavior in recent years with firms becoming more focused on profits rather than market share as in the past (see Hayakawa and Maeda (2000)). This change could reflect a range of factors, including the impact of increased competition, deregulation, a reassessment of growth prospects, improved risk assessment by banks, and increasing reliance on capital market financing associated with financial sector reforms. The surge of foreign and individual investment in the Japanese equity market (Figure V.10), as well as the unwinding of low-return cross-shareholdings by the corporate sector and former main-banks, is also likely adding to pressures on firms to raise ROE.
Japan: Composition of Shareholders
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: WEFA, Norrua DatabaseJapan: Composition of Shareholders
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: WEFA, Norrua DatabaseJapan: Composition of Shareholders
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Source: WEFA, Norrua Database20. While margins increased gradually through most of the 1990s, the rise seems to have accelerated in the last few years (Figure V.11). Gross margins for all enterprises rose from just below 20 percent in 1996 to almost 21 percent in 1997 and to 21.7 percent in 1999. This feature is most apparent for smaller-sized enterprises with capital of ¥10 million to less than ¥100 million. Gross margins in the manufacturing sector peaked in 1997–1998, whereas nonmanufacturers’ margins increased steadily after 1997.11
Japan: Corporate Markups 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Ministry of Finance, WEFA, Nomura database; and staff estimates.1/ Shaded areas indicate recessions, starting at the peak and ending at the trough, based in EPA’s designation.2/ Gross margin is defined as: (Net sales-Costs of sales)/Net sales.3/ Definition of the size of enterprises:Large enterprises: those with capital of ¥1 billion or moreMedium enterprises: those with capital of ¥100 million to less than ¥1 billionSmall enterprises: those with capital of ¥10 million to less than ¥100 million.4/ Domestic terms of trade is defined as: Quarterly change in gross domestic output prices - Quarterly change in gross domestic input price.Japan: Corporate Markups 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Ministry of Finance, WEFA, Nomura database; and staff estimates.1/ Shaded areas indicate recessions, starting at the peak and ending at the trough, based in EPA’s designation.2/ Gross margin is defined as: (Net sales-Costs of sales)/Net sales.3/ Definition of the size of enterprises:Large enterprises: those with capital of ¥1 billion or moreMedium enterprises: those with capital of ¥100 million to less than ¥1 billionSmall enterprises: those with capital of ¥10 million to less than ¥100 million.4/ Domestic terms of trade is defined as: Quarterly change in gross domestic output prices - Quarterly change in gross domestic input price.Japan: Corporate Markups 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Ministry of Finance, WEFA, Nomura database; and staff estimates.1/ Shaded areas indicate recessions, starting at the peak and ending at the trough, based in EPA’s designation.2/ Gross margin is defined as: (Net sales-Costs of sales)/Net sales.3/ Definition of the size of enterprises:Large enterprises: those with capital of ¥1 billion or moreMedium enterprises: those with capital of ¥100 million to less than ¥1 billionSmall enterprises: those with capital of ¥10 million to less than ¥100 million.4/ Domestic terms of trade is defined as: Quarterly change in gross domestic output prices - Quarterly change in gross domestic input price.21. Rising corporate margins in recent years could also reflect the counter-cyclical behavior observed in other countries, as suggested by some game theory approaches.12 An empirical study by Rotemberg and Woodford (1999) concluded that U.S. data were consistent with counter-cyclical markups. Although empirical studies using Japanese data are not available, changes in the domestic terms of trade suggest a tendency of margins to rise in economic downturns in the manufacturing sector—gross domestic output prices have increased more rapidly than gross input prices in most of the recessionary periods in the past, implying rising margins per unit sales (Figure V.11 (bottom panel)).
F. Household and Business Perceptions About Price Developments
22. Another factor that could be supporting the price level is biased perceptions of households and businesses. If prevalent, misperceptions of current price developments could have contributed to downward price rigidity in recent years.13 The top panel of Figure V.12 shows the movement of the actual core CPI (not adjusted for consumption tax and medical insurance rates) and the Consumers’ Sentiment Index (CSI) about future price developments.14 As the CSI indicates consumers’ expectations of the direction of price developments over a 6-month horizon, the forecast values are shifted two quarters ahead to be comparable with the actual outcome. While developments over the past decade suggest that households’ perceptions have generally moved in line with the actual outcome of the core CPI, they also indicate that the CSI has never crossed the 50 percent line; i.e., a majority of households have expected prices to continue to rise, even when actual prices have been falling. This feature is especially clear during 1997–1998 when the CSI remained well below 50 percent amid the largest decline in the core CPI since 1983. A number of EPA surveys reinforce the view that consumers over-assess current inflation.15
Japan: Perceived and Actual Development of Prices by Different Sectors
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Ministry of Finance; WEFA, Nomura database; and staff estimates.1/ Core CPI is not adjusted for consumption tax factors since the consumers expectations include the impact of such shacks. Four-quarter percent change prior to 1991Q3; annualized percent change over two qusters thereafter2/ In formulating the index for households’ perception of price developments, households are asked to translate their perception of future price developments into one of five altematives-whether such developments seem likely to be: good; slightly good; neutral; slightly bad; or bad for future consumption. Each alternative is given a value of +1, +0.75, +0.5, +0.25, and 0, respectively. Each value is then weighted and totaled to obtain the index, Thus, the neutral perception would have the value of 50.3/ Domestic WFI is adjusted for consumption tax factors since the tax burden is passed through to the ultimate consumers.4/ Diffusion index is calculated by subtracting the percentage of tile total with perception of price falling from that with perception of price rising. Thus, the neutral perception would have the value of 0.Japan: Perceived and Actual Development of Prices by Different Sectors
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Ministry of Finance; WEFA, Nomura database; and staff estimates.1/ Core CPI is not adjusted for consumption tax factors since the consumers expectations include the impact of such shacks. Four-quarter percent change prior to 1991Q3; annualized percent change over two qusters thereafter2/ In formulating the index for households’ perception of price developments, households are asked to translate their perception of future price developments into one of five altematives-whether such developments seem likely to be: good; slightly good; neutral; slightly bad; or bad for future consumption. Each alternative is given a value of +1, +0.75, +0.5, +0.25, and 0, respectively. Each value is then weighted and totaled to obtain the index, Thus, the neutral perception would have the value of 50.3/ Domestic WFI is adjusted for consumption tax factors since the tax burden is passed through to the ultimate consumers.4/ Diffusion index is calculated by subtracting the percentage of tile total with perception of price falling from that with perception of price rising. Thus, the neutral perception would have the value of 0.Japan: Perceived and Actual Development of Prices by Different Sectors
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: Ministry of Finance; WEFA, Nomura database; and staff estimates.1/ Core CPI is not adjusted for consumption tax factors since the consumers expectations include the impact of such shacks. Four-quarter percent change prior to 1991Q3; annualized percent change over two qusters thereafter2/ In formulating the index for households’ perception of price developments, households are asked to translate their perception of future price developments into one of five altematives-whether such developments seem likely to be: good; slightly good; neutral; slightly bad; or bad for future consumption. Each alternative is given a value of +1, +0.75, +0.5, +0.25, and 0, respectively. Each value is then weighted and totaled to obtain the index, Thus, the neutral perception would have the value of 50.3/ Domestic WFI is adjusted for consumption tax factors since the tax burden is passed through to the ultimate consumers.4/ Diffusion index is calculated by subtracting the percentage of tile total with perception of price falling from that with perception of price rising. Thus, the neutral perception would have the value of 0.23. Forecasts made by the corporate sector seem to be more sensitive to the actual evolution of prices. The Tankan quarterly survey by the Bank of Japan produces diffusion indices (DI) for corporate perceptions of the direction of price developments one quarter in the future, as well as for contemporaneous price developments. The bottom panel of Figure V.12 shows that the forecast DI, shifted one quarter rightward, has moved in parallel with the actual movement of the domestic WPI (adjusted for consumption tax factor).16 Yet, the comparison between the expected price movements and the assessment of current price movements shows that the corporate sector still has a tendency to overestimate inflationary risks (Figure V.13).
Japan: Gaps between Corporate Sector’s Perception of Future and Current Prices 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: WEFA, Nomura Database.1/ The gaps are calculated by subtracting the current duffusion index from the forecast diffusion index in the previous quarter.Japan: Gaps between Corporate Sector’s Perception of Future and Current Prices 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: WEFA, Nomura Database.1/ The gaps are calculated by subtracting the current duffusion index from the forecast diffusion index in the previous quarter.Japan: Gaps between Corporate Sector’s Perception of Future and Current Prices 1/
Citation: IMF Staff Country Reports 2000, 144; 10.5089/9781451820591.002.A005
Sources: WEFA, Nomura Database.1/ The gaps are calculated by subtracting the current duffusion index from the forecast diffusion index in the previous quarter.24. These observations are consistent with studies focusing on the formulation of inflationary expectations in Japan: see, for example, Nakayama and Ooshima (1999). They reported that inflationary expectations by households remained positive even in deflationary periods (1998–1999), while leading the actual movement of the core CPI by 3 quarters on average. Expectations of the business sector, on the other hand, did not show downward rigidity, and the movement coincided with the actual movement of domestic WPI.
G. Conclusions
25. This chapter has identified a number of factors that could help explain the “unemployment-deflation” puzzle in Japan, without appealing to nonlinearities in the Phillips curve or possible overestimation of the output gap. Downward rigidity of nominal wages does not appear to be responsible for the absence of more pronounced deflation in Japan, as nominal wages (including bonuses) have in fact shown considerable flexibility, particularly after considering that ongoing corporate restructuring is likely to have increased the natural rate of unemployment, thereby reducing the degree of downward wage pressure (and price pressure) one might expect from any given degree of unemployment. On the other hand, rising markups associated with firms’ increasing focus on profits over market share do appear to provide a partial explanation. The persistence of inflationary expectations among both households and (to a lesser degree) the corporate sector, despite ongoing mild deflation, also appears to have supported prices from falling further. While mismeasurement of the output gap and nonlinearities in the Phillips curve may be part of the story, the factors identified in this chapter should also be taken into account in forming a view of why deflationary pressures have not been more severe given the deterioration in Japan’s economic performance in recent years.
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For Figure V.2, adjustments are made to the original CPI series by eliminating the effects of exogenous factors, such as changes in indirect tax rates, to focus on the underlying development of prices. Estimates by the Economic Planning Agency (EPA) suggest that the introduction of the consumption tax (at 3 percent) in April 1989, coupled with the repeal of various excises, pushed up the overall CPI by 1.2 percent for the initial years, and 1.1 percent afterwards, with the phasing-out of transitional treatment on automobiles. The EPA also estimated that the increase in the consumption tax rate in April 1997 (to 5 percent) pushed up the CPI by 1.5 percent and the reform in the medical insurance system in September 1997 had an additional effect of 0.2 percent. As the weight of the fresh food component in the CPI is only 5 percent, the above estimates for the overall CPI are used for the adjustment of the core CPI.
The international evidence on the linearity of the short-run Phillips curve is mixed. For example, evidence of nonlinearity can be found in: Laxton, Meredith and Rose (1994), Debelle and Laxton (1997), Clark and Laxton (1997), and Nishizaki and Watanabe (1999), while the case for linearity is apparent from Turner (1995), Summers (1988), Gordon (1994), and Research Committee on Fundamental Issues Regarding Prices under Zero Inflation (abbr. “Kentou Iinkai” (1999)).
Among major OECD countries, Canada, Germany, Italy, Japan, Korea, and the United States use Laspeyres indices, while France and the United Kingdom use chained Laspeyres indices (as of March 1998 for the U.S., and October 1998 for others).
The Bank of Japan, in its compilation of the wholesale price index and corporate service price index, partially employs a hedonic approach (Bank of Japan (1998)) and introduces new products (services) into the basket more promptly than in the case of the CPI.
The authorities’ official view is that there is no clear evidence of an upward bias in the Japanese CPI series (OECD (1997)). However, the Management and Coordination Agency, which compiles the CPI, acknowledges the potential effect of quality changes and the introduction of new products on the accuracy of the CPI inflation, and accordingly has announced that new items including personal computers and mobile phone services will be added to the sample basket in the next revision for 2000 base.
The report “Toward a More Accurate Measure of the Cost of Living,” known as the “Boskin Report,” was presented to the U.S. Senate Finance Committee in December 1996, by its Advisory Commission to Study the Consumer Price Index, led by former CEA Chairman Michael Boskin. It classified the sources of measurement error into: a) upper level substitution, b) lower level substitution, c) new products/quality change, and d) new outlets. Shiratsuka followed a similar classification and suggested that the new product/quality change effect was larger in Japan and substitution effects smaller.
As the equation uses lagged inflation as a proxy for expected inflation, the estimation started with twelve lags after Fuhrer (1995), eliminating lagged terms in turn until the coefficients on lagged inflation became statistically significant.
Monthly Labor Statistics released by the Ministry of Labor include nominal cash earnings and a nominal cash earnings index adjusted for the gap due to sample changes. The adjusted index is used here to gauge nominal wage developments over time.
Total cash earnings comprise special earnings (primarily bonus payments) and contractual earnings, which can be further decomposed into scheduled earnings and non-scheduled earnings (primarily earnings from overtime work).
Tachibanaki, Fujiki and Nakada (2000) suggest that institutional factors, such as tax thresholds, may have kept female part-timers’ payrolls at low levels despite the fact that the demand for such part-timers seems to have exceeded the supply in recent years.
This picture coincides with market views that show the relative difficulty of some larger manufacturers in the so-called “old Japan” to shift their corporate behavior.
For details on counter-cyclical markups, see, for example, Rotemberg and Saloner (1986) and Rotemberg and Woodford (1991 and 1999). Arguments for pro-cyclical markups can be found in, for example, Green and Porter (1984).
Unfortunately, no data are readily available on expectations of future inflation rates in Japan, as there is no market for indexed government bonds, and the surveys of expected inflation rates are limited. However, as discussed below, it is possible to draw some implications from existing indicators and some limited surveys on the future course of price developments.
The source of the CSI is the Consumer Behavior Survey by the EPA. In formulating the index, consumers are asked to translate their perception of future price developments into one of five alternatives—whether such developments seem likely to be good, slightly good, neutral, slightly bad, or bad for future consumption (falling prices would be regarded as having a favorable impact on consumption). Each alternative is given a value of +1, +0.75, +0.5, +0.25, and 0, respectively, and the values are added up to obtain the index. Consequently, when the consumers’ aggregate perception is neutral, the index will have the value of 50. In order to match the time horizon of consumers’ forecasts before and after the change in the survey questionnaire (1 year through the first quarter of 1991 and 6 months since the second quarter), changes in the core CPI over 2 quarters are compounded to obtain the annualized inflation rates for the period after the change.
For example, a survey in 1996 concluded that almost 60 percent of the sample expressed that they felt the price level to be rising by more than 2 percent (of which about 42 percent chose “2–3 percent increase”) over the past 12 months, despite the fact that contemporaneous CPI inflation (including fresh food) was only 0.6 percent.
Changes in the domestic WPI over 3 months are compounded to obtain the annualized inflation rates. The EPA estimated the impact of the consumption tax rate hike in April 1997 on the WPI to be about 1.9 percent.
