During “Japan’s lost decade” of stagnation, interest rates were almost zero and

Question

During “Japan’s lost decade” of stagnation, interest rates were almost zero and monetary policy ineffective, a situation we call a “liquidity trap”. A way out of the liquidity trap would be through inflation, generated for instance by very expansionary fiscal policies. However, inflation was not created in Japan. Some analysts believe this is due to Japan’s demographic structure that is characterized by a very high percentage of elderly people. Explain why these analysts believe Japan’s demography gave rise to anti-inflationary (in fact, deflationary) policies.

Explanation / Answer

Elderly have low earning capacity and generally are considered to be dependent on young population for their needs. This leads to lower income as compared to young population. Thus, reduces aggregate demand of elderly as compared to young population as aggregate demand is directly related to income of the consumer. Fall in income at old age leads to fall in consumption level at old age. Decline in aggregate demand leads to fall in inflation rate of the economy. Thus, analysts believe that Japan's demography gave rise to anti inflationary policies.

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