Fighting Against the Tide.

Looking back at Japan’s lost decade (1990s) which has now been identified as a real life interpretation of a liquidity trap; which theoretically could last indefinitely,( and in fact has since been redefined as Japan’s lost decades (1990s & 2000s)) we can see growth has rarely topped 2% by year on year change in GDP seen below;

Inflation; which is no longer in the full control of the Japanese Government has seemingly reflected changes in growth (shown below). This can be related to evidence put forward by Paul Krugman (1998) that prices in a liquidity trap are not affected by money supply but more so by demand that is driven by future expected prices. Future prices as I alluded to previously are dependent on people’s perceived future growth, which will likely represent some smoothed lagged function of current growth at any given time. As the populations perceived future growth is based loosely on current growth and will dictate where people spend or save.

The premise of the theories set before are most evident in 2007 as the largest increase in inflation occurs at the height of the U.S and Europe property bubble just prior to the “Financial Crisis of 2008”. We also note continued bouts of deflation from 1999 to 2010 that are consistent with lows in economic growth.

So the question is now how change the Japanese government and its central bank (Bank of Japan) exert the most influence future expected prices, in the hope of lick-starting an increase in demand for money?