Is Japan finally breaking free from the economic chains of deflation? In early 2015, that seemed to be the case, or at least that is what Prime Minister Shinzo Abe had in mind. The only caveat to this declaration, according to the Prime Minister, would be if Japanese companies suddenly decided to stop increasing wages.
The struggling Japanese economy has been a subject of great analysis in the 21st century. In October 2007, economists Christian Broda and David Weinstein offered their views on the deflation effect in Japan, which at that time was showing some signs of improvement. Christian Broda is the Managing Director of Duquesne Capital Management, a New York-based investment firm; he received his Ph. D. in economics from the Massachusetts Institute of Technology and has been awarded two research grants by the National Science Foundation.
What Christian Broda and David Weinstein posited in their 2007 paper “Defining Price Stability in Japan: A View from America,” was that the true cost of living measured in Japan did not conform to traditional measurements in the United States. Christian Broda argued that the Consumer Price Index (CPI), as calculated by Japanese economists, tends to measure inflation in a way that differs significantly from true cost-of-living. Furthermore, Broda and Weinstein presented the issue of substitution bias in Japan, which essentially means that consumers tend to purchase more goods when they drop in price.
To explain substitution bias in Japan, Broda and Weinstein chose beer as examples of consumer goods. For example, when Sapporo and Kirin beer are both priced at 300 yen, Japanese consumers may choose either one based on individual preference. In deflationary times, Japanese breweries may attempt dynamic pricing techniques for the purpose of staying relevant in the market. If the price of Sapporo skyrockets to 600 yen while the price of Kirin is halved to 150 yen, it is natural to think that beer lovers in Japan will shift to Kirin during hard times. This consumer behavior is not commonly taken into consideration when Japanese economists calculate CPI, which on the surface may result in a calculation that suggests more beer is being purchased. In the U.S., there are methods to correct substitution bias, but these are not widely used in Japan.
Now that Prime Minister Abe is ready to call an end of deflation in Japan, it is important to consider Christian Broda’s research on this topic. If you want to read more of Christian’s publications, you can check out his Twitter profile where he features some articles like his piece on overconsumption.