Nasty tricks with inflation in Japan

Consumer price index is a common measure of the overall price change in modern economies, which represents a broader indicator of the cost of living. For Japan, this measure has become extremely important during the last decade because of its very low if not negative value. Economists usually panic when cost of living decreases. Price deflation is a major danger for long term economic growth since bank credits (read investments) are highly suppressed.  Everybody knows: no investment -  no growth.  Hence, any news about positive inflation is welcome and no tricks are bed to get this news.

Figure 1 shows the evolution of two integral inflation measures for Japan: the cumulative CPI inflation and the cumulative GDP deflator (DGDP).  The latter covers all prices in a given economy, while the CPI only a part of them related to consumer goods and services. By definition, the DGDP should nest all CPI items, but the CPI is calculated in a different way based on a basket of goods and products with their shares fixed over a few years. In that sense, the CPI does not follow all economic changes up.

The graphs in Figure 1 are different from inflation indices expressing the absolute change in price level. The cumulative inflation time series describes the relative change in the overall price.  The difference between the DGDP and CPI is dramatic and increases since 1974. From 1974 to 2012, the difference between the cumulative inflation reached 0.37, and the rise in CPI inflation is by ~50%  larger than that in the DGDP.

What is the reason?

The DGDP plays a different role in economics. This is the most important value for real GDP growth. Real GDP is not a measured macroeconomic variable, but rather the ratio of the nominal GDP and the GDP price deflator. Larger DGDP values give smaller real GDP. 

So, this is very important to keep the DGDP as low as possible and the CPI as high as possible. This is a   nasty trick which, mathematically, must result in negative absolute prices of all goods and services not in the CPI.  Do not trust the CPI estimates in Japan. Figure 2 shows two countries without such a dramatic difference between CPI and DGDP: Austria and France. In the USA, the difference between CPI and DGDP has been also increasing since 1978 (Figure3). But the FRB prefers to use Purchase Consumer Expenditures (PCE) instead of the CPI to characterize consumer prices. Figure 4 shows that the DGDP and PCE are similar in the USA. 

Figure 1. The evolution of cumulative rate of CPI inflation and GDP deflator in Japan. 

 

 

  

Figure 2.  The evolution of cumulative rate of CPI inflation and GDP deflator in Austria and France.

Figure 3.  The evolution of cumulative rate of CPI inflation and GDP deflator in the USA.

Figure 4.  The evolution of cumulative rate of PCE inflation and GDP deflator in the USA.