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Long-run mild deflation under fiscal unsustainability in Japan

Makoto Saito () and 誠 齊藤

No 703, Discussion Paper Series from Institute of Economic Research, Hitotsubashi University

Abstract: A macroeconomic policy debate has been ongoing in Japan for over the past two decades, with one side proposing drastic fiscal reforms to avoid hyperinflation and the other recommending expansionary policies to escape from a liquidity trap. However, neither side has been able to explain why mild deflation has continued for such a long time, despite primary budget deficits and unprecedented monetary expansion. This paper presents an alternative theory, arguing that fiscal sustainability will be restored in the future not as a result of drastic fiscal reforms, hyperinflation, or continuous mild inflation, but largely through a one-off surge in the price level, such that the price level becomes several times higher than before. Such a price surge is considered a rare event accompanied by catastrophic endowment shocks in the following years. Within this framework, mild deflation coexists with fiscal unsustainability until this sharp surge in the price level occurs.

Keywords: the fiscal theory of the price level; fiscal sustainability; mild deflation; price surges; yield curves (search for similar items in EconPapers)
JEL-codes: E31 E41 E58 E63 (search for similar items in EconPapers)
Date: 2020-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:hit:hituec:703

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