Since 1990 Japan has experienced over a decade of slow growth in real economic activity. Between 1990 and 2000 per capita output raised at an annual rate of 0.68 percent, per capita investment dropped at the rate of 1.4 percent per annum and weekly hours per adult worker declined by 1.18 percent per annum.
This period has come to be referred to as "the lost decade." During the same period the inflation rate, as measured by the growth rate of the GDP deflator, fell from 2.3 percent to -1.8 percent and the nominal interest rate fell from 7.4 percent to 0.1 percent. Japan's current experience of sluggish growth coupled by deflation and zero nominal interest rates raises questions about the role of monetary policy in times of deflation. Should monetary policy take actions to avoid the zero nominal interest rate bound and if so, what policies can avoid it and/or ameliorate its negative ejects? This paper deals with a model that accounts for the real and nominal facts from the 1990s and makes use of this model to answer the two questions posed above.
We consider an expensive price adjustment model along the lines of Rotemberg (1996) and expand it to allow for capital accumulation. In this economy, monopolistically competitive firms face convex costs of adjusting prices. Households own the capital stock and are subject to convex costs of adjustment. ...Show more