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Deflation and Economic Growth in Japan

Komeil Deghani, Ehsan Rajabi, Lee Chin, Junaina Muhammad


Fear of deflation leads to the hypothesis that deflation can have influential negative impact on growth.

This paper aims to examine the relation between deflation and growth slowdown of the Japan economy through threshold effect. By using quarterly time series data from 1965 to 2010, log functional form and OLS threshold regression method, the research found existence of the threshold effect which is significant statistically and strong economically. The threshold point of mild deflation is actual true zero inflation. Below this point, the negative impact of deflation will occur on growth. However this finding is sensitive to period of study.

Negative threshold impact of deflation turn to be insignificant if period 1990 to 2010 is taken. In addition, deflation has positive impact on economic growth. These finding which are observed from period with prevalence of deflation is in striking contrast with predication of fear of deflation theory of Keynesians but consistent with Austrian Business Cycle and productivity norm deflation theories. Hence, reasons for fear of danger of deflation in the case of Japan cannot be justified.


Deflation; Economic growth; Threshold

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