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A tale of two deflations

August 5, 2019

A tale of two deflations

Japanification is a term that has re-emerged recently.  It refers to the prolonged economic stagnation of Japan, which commenced after a financial crash in the early 1990s. The stagnation of Japan has been marked by very low inflation (recurring periods of deflation), stagnating productivity growth and a massive increase in government debt.

However, at the same time as the financial crisis that started the long stagnation in Japan, there was a similar crisis in a small northern country, Finland. Finland had followed such a similar economic trajectory as Japan that it was dubbed the “Japan of the North”. However, while Japan fell into a prolonged economic malaise, the Finnish economy returned to growth just four years after the onset of the crisis (see Figure 1).

What caused the difference between these two outcomes?

Figure 1. Volume of nominal, local currency GDP per capita in Finland and Japan between 1969 and 2018 (1969=100). Note: due to the recurrent deflation periods in Japan, comparisons using the constant (real) GDP per capita are not feasible. Source: GnS Economics, World Bank

The boom of Finland and Japan

Both Japan and Finland were relatively poor countries in the 1950s. Both were on the losing side of the Second World War (Japan had primarily fought against the U.S. and Finland against the Soviet Union) which made them temporary outcasts in the new global political order. After they regained a place in global politics, both established an ambitious industrialization program.

In both countries monetary and fiscal policies, under a regime of currency regulation, were used to channel resources towards industrialization. Capital flows were tightly-managed, and interest rates were set below market-clearing levels. This forced national savings toward investment and allowed for only essential consumption.

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