Purpose: This study evaluates the impact of price changes on Japanese consumption from 1970 to 2022, which include not only an inflation period but also an exceptionally extended period of deflation.
<br>Research design, data, and methodology: The theoretical framework of Lettau & Ludvigson (2001) from dynamic budget constraints was used to analyze the peried from 1970 to 2022 in Japan, which was divided into two peiod including the inflation period from 1970 to 1994 and the deflation period from 1995 to 2022. Engle-Granger co-integration and error correction were employed for the estimation.
<br>Results: A co-integration relationship between private consumption expenditure, real estate wealth, net financial asset, and labor income was found. When the inflation variable was added to the short-term consumption function estimated by the error correction model, the explanatory power of the consumption model was improved. In particular, an increase in the inflation was found to have an adverse effect on consumption. This adverse effect was observed not only in the inflation period but also in the deflation period. However, the statistical significance was weakened.
<br>Implications: According to the study, the government is advised to provide stable moderate inflation to mitigate the adverse effect of the increase in the inflaiton on consumption. Thus, the government is recommended to maintain a prudent monetary policy to stabilize inflation to increase consumption. The Japanese experience also provides significant implications for Korea, which is following Japan’s low-growth paradigm due to its population structure, etc. If deflation has a stimulating impact on consumption, excessive intervention to eliminate the deflation in a recession needs to be cautious and gradual.
