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Japan's nominal GDP and money supply: A wide divergence

Author(s): Atsushi Nakajima

The Japanese economy has been on a recovery track since mid-2012, due in part to Abenomics. Although the economy has slowed recently, it is expected to turn upward again, thanks to additional fiscal and economic measures, high stock prices coupled with the weak yen, and the low price of oil.


A policy that particularly merits attention is the quantitative easing by the Bank of Japan with its goal of purchasing 80 trillion yen of Japanese government bonds annually as it strives to achieve a 2% price stability target. Long-term interest rates are at its lowest level ever, between 0.2% and 0.3%. Moreover, because of trends such as the growing gap between Japan and U.S. interest rates, Japan is seeing high stock prices coupled with the weak yen. These can be expected to further improve business/consumer confidence and inflation expectations from both corporations and households.

A look at the Japanese nominal gross domestic product (GDP) and the money supply (M2 base) in recent years shows that whereas the money supply continued to increase from the mid-1990s until recently, nominal GDP has been flat. Such a long-term deviation between nominal GDP and the money supply seems highly irregular as economic growth typically indicates additional demand for financing. If the money supply increases sharply, financial assets and real estate prices rise while exchange rates fluctuate, and such trends are expected to have an impact on economic growth as well. In the major economies of Europe and North America, nominal GDP and money supply grow together.

So why are nominal GDP and the money supply diverging so conspicuously from each other solely in Japan? One reason has to do with where the money is diverted to once the supply has increased. The most important part of the increase in the money supply since 1995 has gone toward purchasing the expanded amount of Japanese government bonds. In other words, the money went into public works, which have a lower economic multiplier effect than private investment.

The biggest reason of all has to do with business behavior. In the last 20 years since the collapse of the real estate bubble, businesses increasingly have shown a tendency to contract and households have not been able to increase their consumption. Given this background, domestic demand has been sluggish and deflation has kept nominal GDP in check. The impact of deflation has been particularly significant. Assuming that Japan's rate of price increases (GDP deflator) had been the same as that of the United States, that, combined with Japan's nominal GDP, would lead to a big increase consistent with growth in the money supply (Fig. 1).

Figure 1: Changes in Japan's Nominal GDP and Money Supply

Figure1: Changes in Japan's Nominal GDP and Money Supply

(Note) "Adjusted nominal GDP" refers to Japan's GDP deflator adjusted with that of the United States
(Source) Bank of Japan, Cabinet Office, Ministry of Internal Affairs and Communications, U.S. Bureau of Economic Analysis


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