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short essays and reports on the economic issues of the day
2003 ■ Number 22

Japanese Deflation Loses Something in the Translation
James B. Bullard and John Seiffertt
“Indeed, there is an especially pernicious, albeit remote,
scenario in which inflation turns negative against a backdrop of weak aggregate demand, engendering a corrosive
deflationary spiral.”
—Alan Greenspan, testimony before Congress, July 15, 2003

the chart suggests deflation in the United States is unlikely.
Possibly, a negative shock to the U.S. economy could cause
a temporary decline in the price level. But most analysts
would agree that, to obtain a Japanese-style deflation in the
United States, the pace of monetary expansion would have
to slow significantly from its present pace and remain slow
for some time. Based on this thinking, the chances of deflation occurring in the United States appear to be “remote”
Of course, other factors may have influenced inflation in
Japan. First and foremost, real performance has been poor,
with real GDP growth near zero or negative in four of the
past five years (in 2000, the economy expanded). Other
problems include a large portfolio of bad loans held by
commercial banks and, perhaps critically, the unanticipated
nature of the onset of deflation in Japan. Still, slow or stagnant monetary expansion is a prerequisite to ongoing deflation. Recent statements, such as the quotation above, suggest
U.S. monetary authorities are watching and remain ready
to act decisively should deflation become more than a
remote possibility. ■

n recent months, market analysts have been reacting
to comments by Federal Reserve officials, such as
Chairman Greenspan’s testimony before Congress
quoted above, concerning the possibility of Japanese-style
deflation in the United States. As the Chairman emphasized,
such a possibility is remote. Why “remote”? The type of
deflation under discussion here involves a long, steady price
level decline, not just a temporary one- or two-month blip
of deflation. But such a long price level decline would normally be supported by sustained, slow rates of monetary
expansion. Japan has experienced slow rates of money
growth in the past five years, but the United States has not.
The chart shows M2 growth for the United States and
Japan, measured on the right axis, along with the consumer
price index (CPI) inflation rate for each country, measured
on the left axis. Growth is calculated as a yearover-year rate, recording the percent change in
A Tale of Two Countries, 1998-2003
the measures from the previous year. It is evident
from the chart that the relatively high rate of
CPI Inflation (%)
money growth in the United States has been
associated with a positive rate of inflation, while
the relatively low rate of money growth in Japan
has been associated with deflation. This pattern
is especially clear over the past three years, dur2.0
ing which Japan has experienced a consistent
deflation of about 1 percent per year. Money
growth has been significantly faster over this
horizon in the United States than in Japan, consistent with the faster rate of CPI inflation in
the United States.
Assuming that Federal Reserve officials are
intent on maintaining the pace of monetary
Japan CPI
expansion around the level of the past five years,


Views expressed do not necessarily reflect official positions of the Federal Reserve System.

M2 Growth (%)

Japan M2