Price Level
AD2
AD1
O Real GDP
The above increase in Aggregate Demand causes an even greater change in the national income.
In this situation, the Keynesian Multiplier effect is bound to take place since, this increase in Investments and Consumer Spending would increase the incomes of those firms where the money has been invested or spent, this would in turn boost the spending of those firms who receive this extra income, and they would go ahead and spend it too. At each stage of the cycle, the extra spending becomes lesser and lesser due to leakages such as taxes and spending on imports, however, finally, this initial increase in the spending leads to a bigger increase in the national income.
The diagram below briefly summarizes this effect:
Households
Increase in Autonomous Spending
Firms
With the appreciation of the Yen, the investors lost out on speculation of bonds; where they had predicted that due to the increase in wages, there would be much more consumer spending giving birth to inflation. Due to this, the investors withdrew or reduced bonds and investments afraid that the value of their money would reduce and they would receive lesser than they had invested initially.
This in turn, enabled the Bank of Japan to utilize their monetary policy of interest rates, an increase in it would act as a corrective measure for the speculated inflation, since, due to high interest rates, consumers would be tempted to save; which would reduce consumer spending. Consumer Spending being a component of Aggregate demand would result in reducing aggregate demand since AD = C + G + I + (X – M).
Thus with the decrease in investments and consumer spending, the aggregate demand would also decrease. Subsequently, aggregate demand would shift to the left, reducing prices automatically, eliminating inflation.
Price Level
AD1
AD2
O Real GDP
However, the Phillips Curve contradicts how inflation can be eliminated through their low unemployment rates.
Inflation Rate (%)
A
B
O Unemployment Rate (%)
Since wage form a high percentage of total costs, it is strongly reflected in final prices, creating a relationship between unemployment and inflation. As unemployment rate rises, inflation decreases. In their case since their unemployment rates are low, thus inflation may be initiated.
The “risk of excessive investments” may raise interest rates, this works since, more investors want to invest, irrespective of the risks, hence by increasing interest rate, they may convince them to save. Thus they “doubled their lending rate”.
Furthermore, “Consumer spending helped Japan’s economy grow”, this does aid Japan’s growth, due to high demand for goods and services resulting in high supply of goods and services.
But I feel there is a drawback to this too, since, if aggregate demand increases too much, it could lead to major inflation.
Moreover, their unemployment rate falling has not shown all its positive effects yet; the high demand for labor is supposed to indirectly increase growth of the country. However, retiring employees are being substituted by younger employees, who are willing to work for less wages, due to which the wage growth has not begun yet. In addition to this, there is a great utilization of part time workers, who are paid normally just hour wise, this type of pay does not encourage any kinds of wage spurs!
And lastly, since companies want to keep labor costs low, it would affect the fact that the demand for labor wouldn’t be too high, nor would there be a sudden increase in wages, as wages are a critical element of their costs.
Therefore, Japan is definitely on the right track, but should be careful about avoiding inflation and remember that slow and the steady wins the race.
Glanville, Page number: 265
Glanville, Page number: 308
