Tuesday, January 28, 2014

Ageing and deflation in Japan

Inflation rates across industrialized economies have been remarkably low in the past decades, and at the same time these economies have been subject to considerable demographic ageing. Nowhere has this been more true than in Japan. What are the government's or the central bank's incentives to set policy that triggers lower inflation if the population gets older? I do not see where monetary policy would matter, but the fiscal theory of inflation may tell us something.

Hideki Konishi and Kozo Ueda study the latter in an overlapping generation model where the fiscal authority has a shorter lifespan than residents, but takes into account the impact of its actions on future governments. The fiscal theory of the price level tells us that inflation goes up when more debt is accumulated, and that is certainly the case when the population gets older and requires more retirement benefits. But the authors point out that this does not necessarily hold once you take into account the endogenous responses of income tax rates and public expenses. Then, because of the policy response it matters why the ageing is happening: lower mortality or lower fertility. Deflation is more likely in the former case. Now we just need someone to bring this to the data...

No comments: