8/3/13

Spell abenomics as “abe_NO_mics”

Abenomics is a modern word to express desperation of Japan economic and financial authorities after 20 years of lower real economic growth and almost 15 years of deflation.  The current PM Shinzo Abe has introduced a monetary policy to overcome deflation. However, the long term evolution of consumer prices and the GDP deflator is not related to any monetary policy and has been driven by the change in labor force. In turn, all labor force projections for Japan clearly demonstrate that price deflation will extent into the second part of the 21st century.  

In that sense, abenomics should be spelled as “Abe_NO_mics” . 

We have already mentioned that Japan is the best illustration of our concept linking inflation/unemployment to the change in labour force. In our previous post on the GDP deflator in Japan published a few days ago, we showed two cumulative curves for observed and predicted inflation since 1980. Here we revisit similar CPI curves also two more readings and conclude that our concept is quantitatively excellent. The underlying data have been borrowed from the OECD and Japan Statistics 

Using stata9 and allowing a structural break, we sought for the best-fit (in RMS sense) coefficients in the linear and lagged link between inflation and labour force. Because of the structural (measurement related) break in the 1980s, we have chosen the period after 1981 for linear regression, which is common for almost all economic studies related to Japan. By varying the lag and coefficients we have found the following relationship for consumer price inflation (CPI): 

CPI(t) = 1.39dLF(t-t0)/LF(t-t0) + 0.0004           (1) 

where the time lag t0=0 years; Figure 1 depicts this best-fit case. There is no time lag between the inflation series and the labour force change series in Japan. Free term in (1), defining the level of price inflation in the absence of labour force change, is close to zero but negative.  

A more precise and reliable representation of the observed and predicted inflation consists in the comparison of cumulative curves (a version of CUSUM technique) shown in the lower panel of Figure 1. We always stress that the cumulative values of price inflation and the change in labour force are the levels of price and labour force, respectively. Therefore, the summation of the annual reading gives the original estimates of price and workforce, which when are converted into rates.
 

Another advantage of the cumulative curves is that all short-term oscillations and uncorrelated noise in data as induced by inaccurate measurements and the inevitable bias in all definitions are effectively smoothed out. Any actual deviation between these two cumulative curves persists in time if measured values are not matched by the defining relationship. The predicted cumulative values are very sensitive to free term in (1).  

For Japan, the CPI cumulative curves are characterized by very complex and unusual for economics shapes. There was a period of intensive inflation growth and a long deflationary period. The labour force change, defining the predicted inflation curve, follows all the turns in the measured cumulative inflation with the coefficient of determination R2=0.99. The predicted and observed cumulative CPI curves are cointegrated and thus this estimate is consistent. For the annual estimates: R2=0.73.

 

With shrinking population, and thus, labor force, the level of CPI will be falling through 2050 and likely beyond.  

 


Figure 1. Measured CPI inflation and that predicted from the change rate of labour force in Japan. Upper panel:  Annual curves smoothed with MA(3). Lower panel: Cumulative curves between 1981 and 2012. The extremely accurate agreement between the cumulative curves illustrates the predictive power of our model. The cumulative curves are I(1) processes and  it was instructive to test them for cointegration. This test was successful.

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