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 21

^{st}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) =*1.39

*dLF(t-t*

_{0}

*)/LF(t-t*

_{0}

*) +*0.0004

*(1)*

where the time
lag

*t*_{0}=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

*R*=0.99. The predicted and observed cumulative CPI curves are cointegrated and thus this estimate is consistent. For the annual estimates: R^{2}^{2}=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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