Deflation and Macroeconomic Policy: Japanese and European Perspectives

We generalize Lagos and Wright's (2005) framework for monetary economy in a way that there exist two technologies, "high" and "low," for producing the goods in the decentralized matching market. The high technology is more productive than the low technology, while the agents who use the high technology cannot precommit to deliver the goods. The lack of commitment makes it infeasible to produce the goods with the high technology if trade is made with simple cash payment. To use the high technology, privately valuable assets, e.g., residential properties, should be put up as a hostage a la Williamson (1983) in the transaction. In this setting, the balance-sheet deteriorations due to a financial crisis lead to disappearance of residential assets which is not yet put up as collateral, and hinder the usage of the high technology, leading to the decline of the aggregate productivity. In this case, monetary injections cannot restore the productivity after a financial crisis.

The Japanese labor market in the 21st century exhibits symptoms of rigidities that appeared and overshadowed much of Europe in 1980's and 1990's: stagnant job creations, rising trend of unemployment, and segmentations of the labor force into the core with secure jobs, and, the periphery with unstable, low paid jobs. On the other hand, important differences exist between the two labor markets. The difference is most stark in the youth labor market. In spite of repeated (and failed) attempts for a change, the Japanese youth labor market is still sharply divided into the one for school leavers and the rest. We plan to highlight this as the crucial institutional characteristics of the Japanese labor market responsible for much of the differences we find between the two labor markets. For this objective, we plan to build a highly stylized, search theoretic model in which we focus on the determinants of the immobility of labor from stagnant to growing sectors in the economy. We plan to inject alternative institutional settings of the youth labor market to show similarities and differences of the structural problems facing the two economies. Our speculation is that the effectiveness of various policy interventions will differ between the two labor markets, which we hope to demonstrate using calibrated models.

Are prices sticky due to the presence of strategic complementarity in price setting? If so, to what extent? To address these questions, we investigate retailers' price setting behavior, and in particular strategic interaction between retailers, using a unique dataset containing by-the-second records of prices offered by retailers on a major Japanese price comparison website. We focus on fluctuations in the lowest price among retailers, rather than the average price, examining how quickly the lowest price is updated in response to changes in marginal costs. First, we find that, when the lowest price falls rapidly, the frequency of changes in the lowest price is high, while the size of downward price adjustments remains largely unchanged. Second, we find a positive autocorrelation in the frequency of changes in the lowest price, and that there tends to be a clustering where once a change in the lowest price occurs, such changes occur in succession. In contrast, there is no such autocorrelation in the size of changes in the lowest price. These findings suggest that retailers imitate each other when deciding to adjust (or not to adjust) their prices, and that the extensive margin plays a much more important role than the intensive margin in such strategic complementarity in price setting.

Torben M. ANDERSEN is Professor of Economics at the School of Economics and Management, University of Aarhus. He received his Ph.D from CORE, Université Catholique de Louvain, Belgium, and holds a Lic. Oecon from the University of Aarhus and an MSc from the London School of Economics. His primary research and teaching interests are in the economics of the welfare state, labour economics and fiscal policy. He is affiliated to a number of research institutions including CEPR (London), CESifo (Munich), Iza (Bonn), SNS (Stockholm) and the Kiel Institute. Torben M. Andersen has been intensively involved in policy advice in Denmark and abroad, and he has among other things been chairman of the Danish Economic Council, and the Danish Welfare Commission. He is currently a member of the Swedish fiscal policy council.

John DRIFFILL is a Professor of Economics at Birkbeck College, University of London and a CEPR Research Fellow. His current research interests include international macroeconomics and the role of financial market imperfections in business cycles and growth. Prior to joining Birkbeck College, Professor Driffill was professor of economics at the University of Southampton, Queen Mary and Westfield College and Tilburg University. He holds a Ph.D from Princeton University.

Richard PORTES, Professor of Economics at London Business School is Founder and President of the Centre for Economic Policy Research (CEPR), Directeur d'Etudes at the Ecole des Hautes Etudes en Sciences Sociales, and Senior Editor and Co-Chairman of the Board of Economic Policy. His current research interests include international macroeconomics, international finance, credit default swap (CDS) markets and European integration. He has written extensively on international currencies, financial stability, globalisation, sovereign borrowing and debt, European monetary issues, European financial markets, international capital flows, centrally planned economies and transition, macroeconomic disequilibrium, and European integration.

Morten O. RAVN is a Professor of Economics at UCL and a CEPR Research Fellow. He is a graduate of the University of Southampton. Previous to joining UCL, Morten was a professor of economics at the European University Institute and at the University of Southampton, an associate professor at London Business School, and assistant professor at Universitat Pompeu Fabra and the University of Aarhus. He has also been a visiting professor at the University of Pennsylvania.