No. 274 - Deflation expectations and Japan's lost decade

From the early 1990s on, GDP in Japan stagnated for about a decade while inflation remained persistently low, at times even negative. This paper provides new stylized facts about the Japanese deflationary process and puts them into the context of the literature addressing the origins of Japan's lost decade. In order to properly understand the evolution of inflation in Japan and the role of monetary and fiscal policy, a crucial question is whether the deflationary process, a phenomenon specific only to Japan during the period under consideration, was anticipated by agents. The paper suggests that the answer is positive. I show that once a 'global' inflation forecasting error, common across advanced countries, is removed from Japanese inflation expectations, the remaining 'idiosyncratic' inflation forecasting error is close to zero at various forecasting horizons. This indicates that the Japan-specific deflationary process was fully anticipated by agents, with medium-term (and 'idiosyncratic') inflation expectations disanchoring very early along the deflationary path.