The Elusive Costs of Deflation and Zero Lower Bound: Reassessment of the Japanese Economy

Abstract

Since the 1990s, Japan's economy has faced stagnation. A prevalent perception is that this prolonged stagnation is heavily tied to Japan's struggle with deflation and the zero lower bound (ZLB) of nominal interest rates. However, upon closer examination of various measures, we find little evidence supporting this perception and conclude that the costs of deflation and ZLB are elusive. Moreover, we show that a slight extension of the three-equation New Keynesian model can account for Japan's near-zero inflation together with the zero nominal interest rate and low growth. Therefore, any assertion that Japan is trapped by costly deflation and ZLB must first be substantiated by empirical evidence.

JEL Classification: E31, E43, E52, E58