DBJ Discussion Paper Series, No. 1701

Labor Productivity Stagnation,
the Radical Quantitative Easing Monetary Policy,
and Disinflation

Masayuki Otaki(Institute of Social Science, University of Tokyo)

September 2017

The aim of this discussion paper series is to stimulate discussion and comment from academics
and policymakers through a preliminary draft form. This paper is included by permission of theauthor(s) as a tentative material before publication in peer-reviewed journals or books. Copyrightand all related rights are maintained by the author(s). Views expressed in this paper are those of
the author(s) and do not reflect the views of the Research Institute of Capital Formation or
Development Bank of Japan.

Labor Productivity Stagnation, the Radical Quantitative Easing Monetary Policy,
and Disinflation

Abstract
There is an anomaly observed in many advanced economies- disinflation accompaniedby stagnation of labor productivity. In a static barter economy, this phenomenon isincomprehensive because labor productivity stagnation relative to aggregate demandraises price levels. That is, theoretically, disinflation can coexist only with the rapid
progress of labor productivity. I construct an overlapping-generations model (OLG
model), which predicts disinflation caused by slowdown in labor productivity. The crucial
factor is that demand for current goods can decrease when labor productivity slows down.
This implies that disinflation and recession coexist to keep the equilibrium in the goods
market. In addition, I clarify the reason why quantitative easing (QE) policy such as
those seen in Japan and other advanced economies causes mild disinflation.
Keywords: Labor Productivity Stagnation, Radical QE Policy, Disinflation, Stagflation
as Bust of Money Bubble
1 Introduction
As suggested in Table 4.1, disinflation and the slowdown of labor productivity growth isprominent in advanced countries. Beyond the issue of measurement errors, 1 these
phenomena are related to different factors. For example, according to ECB (2016), laborproductivity slowdown in the U.S. is mainly attributed to(i) Decrease in capital deepening, and(ii) the slowdown of total factor productivity (TFP) growth.
On the other hand, as a key variable of disinflation, inflation expectations are
frequently examined although there findings span a wide range. Christensen (2009)
revealed that minor investors held deflationary expectations even during the deflation
era in the U.S. Piazza (2015) found that Japanese deflationary expectations areprominent compared with the world economy. Hori and Shimizutani (2005) showed that
For example, Byrne, Fernald, and Reinsdorf (2016) argue it is difficult to findproductivity slowdown in the U.S. despite the substantial measurement errors.

11Japanese inflation expectations are strongly affected by their own lagged variables.
However, the slowdown of capital deepening or TFP is not consistent with disinflationin the classical static model, regardless of what price expectations may be. For example,
let us consider a classical two production factors linear homogenous production function
model, which the TFP analysis implicitly assumes. If capital deepening decelerates, labor
becomes the abundant resource. Accordingly, the real wage becomes lower relative to thereal rent. Thus, the real wage strictly decreases. Nevertheless, this model does notpossess the power to determine the price level because it is a classical real model, whichcannot introduce money endogenously. Hence, by definition, it is impossible to knowwhether disinflation occurs or not.
Instead, consider the case in which capital accumulation takes time to be effective, andcapital is a quasi-fixed factor in the short run. Hence, labor is the only variable
production resource. In such a case, if nominal wage is fixed, the price level potentially
increases. This is because the real wage must be lowered to maintain full employment
equilibrium. It is not deflation but static inflation. It must be noted that this scenario,
which is based on the standard Keynesian theory, is a variant of the stagflation model ofBruno and Sachs (1985), and thus, neither the neoclassical nor Keynesian type models
can explain the coexistence of disinflation and labor productivity slowdown since a modelis basically static.
Therefore, we must note that disinflation is a dynamic phenomenon in a monetary
economy. The current and future economy is linked through money. In addition, output
price is measured in terms of money. Accordingly, we need a dynamic model with money
to analyze the coexistence of disinflation and productivity slowdown.
The two period overlapping-generations (OLG) model with money is the simplest andmost suitable analytical tool. As developed in Otaki (2007, 2009, 2015), this type of OLG
model has the property that the value of money (the inverse of the price index) is
determined by the rational expectation of its own future value, and thus, unemployment
emerges whenever the real cash balance is sufficiently small with no rigidity assumption
on prices. I assume a linear production function of labor with exogenously given laborproductivity to facilitate the comparative statics.
An exogenous labor productivity slowdown implies that the current potential
aggregated supply is curtailed. Since young individuals’ consumption is an increasing
function of the ex-ante inflation rate, which is equal to the ex-post inflation of the next
period under rational expectation equilibrium (REE), disinflation is provoked toequilibrate the current goods market. Thus, in a monetary economy, disinflation cancoexist with a productivity slowdown.
2

It is important to distinguish between ex-post and ex-ante inflation. Let t be the current
period. Then, the ex-post inflation,  EP , is defined as EP 

pt
.
pt 1

(1)

The ex-ante rational expectation,  EX , which affects young individuals’ decision, is EX 

pt 1
.
pt

(2)

As discussed above, the ex-post inflation rate can be derived from the comparative statics
of a neoclassical model. However, the ex-ante inflation rate, which is equal to the future
actual inflation rate (ex-post inflation rate during period t  1 under REE), can only bederived in dynamic model. It must be noted that what is important for determining theequilibrium is the ex-ante inflation rate, and not the ex-post inflation rate, because those
who substantially determine the resource allocation of the overall economy are thecurrent young generation. The classical static model cannot derive the ex-ante inflation
rate by definition. The strict distinction between the price level and inflation rate is
crucial for macroeconomic theory.
Regarding the origins of deflation, my model is also useful in analyzing theconsequences of the radical quantitative easing (QE) monetary policy. Disinflation
continues in advanced economies despite the intention of the radical QE policy. This isparadoxical for those who follow quantity theory including New Keynesians.2 In contrast
to this, my model can explain this phenomenon.
The OLG model assumes that individuals are confident of the intrinsic value of moneyin the sense that they rationally believe the current price level is independent of thenominal money supply. An increase in the nominal money supply requires deflation. Thisis because the aggregate saving of the young generation should increase to equilibrate
the money market.
The most prominent future of the OLG model is that a change in some stock
macroeconomic variable such as the nominal money supply can directly affect flow
variables. Traditional IS/LM analysis (including sophisticated versions of new
Keynesian) cannot analyze how the new monetary inflow affects the equilibrium
condition of the goods market. If a change in the stock variable is negligibly small, the
IS/LM method can be considered a reasonable first-order approximation. However, theGali (2008) is a standard text of New Keynesian economics. The real cash balance isintroduced in the utility function. This implies that the real cash balance become an
endogenous variable, and hence, the price level varies proportionately to the nominal
money stock, at least, in the long run. This property clarifies that neutrality of money(i.e., quantity theory of money) holds in New Keynesian model.

2

3

volume of the radical QE policy per annum is huge, and thus, the OLG model is far moresuitable than the IS/LM analysis to investigate its effects on the overall economy.
This paper is organized as follows. Section 3.2 constructs a classical static model and a
dynamic OLG model to exhibit different insights into the coexistence of disinflation andlabor productivity slowdown. In Section 3.3, I critically analyze effects of the radical QE
monetary policy by using the OLG model constructed in Section 3.2. Section 3.4 contains
concluding remarks.

2 The Model
2.1 The Classical Real Model
I consider an economy in which one good is produced by one production resource: labor.
The utility function, U , of the representative individual is assumed to be

U  x  G  h  , G '  0, G ''  0 , lim G '  h   0, lim G '  h    ,
h 0

h 

(3)

where x denotes the volume of consumption and h is the hours worked. G   function
represents the disutility from labor. The budget constraint is

Wh  px Wh  x,
p(4)

where W denotes the nominal wage. p is the price of goods.
From the Inada condition in Equation (3), the budget constraint, Equation (4), is always
biding. Therefore, the maximization problem, which the representative individual solves,
is

W
W

 G ' h .
max  h  G  h   
h
p
p



(5)

Production is assumed to be linear on hours worked:x  h.

(6)

Goods and labor markets are under perfect competition. Substituting Equation (4), thezero-profit condition implies  px  Wh  0W  . (7)p

Accordingly, the labor productivity is equalized to the real wage. The equilibrium of thegoods market is illustrated by Point E in Figure 1. It is evident from Figure 1 that the
optimal hours worked, h* , is an increasing function of the labor productivity  . That is,4h*      ,  '  0 .

(8)Here we assume that nominal wage, W , is the numeraire. Then, we can determine theprice of goods in terms of the nominal wage. Let this variable be denoted pw Since thelabor productivity is equal to the real wage (see Equation (7)), the price, pw , always
increases when labor productivity slows down. Thus, ex-post inflation as represented
in Equation (1) is triggered by such a slowdown.
Furthermore, the curtailed real wage decreases the equilibrium hours worked, h* . Thisimplies that stagflation occurs in this economy. It should be noted that this property ofthe static neoclassical model is quite robust as shown in Bruno and Sachs shows.
Figure 2 illustrates the equilibrium of the goods market from the another point of view.
Horizontal line SS is the supply curve is defined in Equation (7).3 The downward-sloping
curve DD is the demand curve of the goods. This curve can be derived in the following
way. First, the optimal hours worked h* is a decreasing function of the goods price pw .
Second, from the budget constraint Equation (4), it is evident that the optimal
consumption, x* , increases in conjunction with h* . Consequently, x* is a decreasing
function of pw , and hence, the demand curve DD becomes downward sloping. The
equilibrium is achieved at Point E .
It is also straightforward from Figure 2 that the equilibrium moves towards thenorthwest point of DD such as Point E1 whenever labor productivity slowdown is
provoked as a consequence of the upward shift of supply curve SS . This is the essence ofthe supply-shock model developed by Bruno and Sachs (1985).
To summarize, the real static model cannot explain the coexistence of disinflation andthe labor productivity slowdown. This fact suggests that a dynamic model with money isneeded to solve this paradox.
2.2 The Two Period Overlapping-Generations Model
I construct a two period OLG model with money and infinite time horizon in a production
economy, which is developed by Lucas (1972) and Otaki (2007, 2009, 2015). The utility
function, V , of representative individual who is born at the beginning period t isV  v  x1t , x2t 1   G  ht  , (9)If the aggregate production is concave, it is easy to show that the aggregate supply
curve SS becomes upward sloping. However, parameter  becomes the TFP at this time.

3

5

where v   represents the utility from lifetime consumption. xit  j denotes theconsumption of an individual during period t  j at the i th stage of his life. This function
is strictly concave and a linear homogenous function. v   also satisfies the Inada
condition. The corresponding budget constraint is

Wt ht  pt  c1t   c2t 1  ,



pt 1
.
pt

(10)

It is well known that the corresponding indirect utility function, ID , of v   can be
represented as

ID 

Wt ht
,
  pt , pt 1 

(11)where    is a monotonously increasing linear homogenous function. The optimal
decision requires the following condition:dWt
IDt  G '(ht )  G '  ht   Wt    pt , pt 1   G '  ht  .
dht
  pt , pt 1 

(12)

Accordingly, the firm’s zero-profit condition requires

pt   Wt R  0  pt   Wt  pt    pt , pt 1   G '  ht   0     1,    G '  ht  . (13)where  is the ex-ante inflation rate as previously defined in Equation (1).
Equation (13) is the implicit aggregate supply function of this model. The right-handside of the equation is an increasing function of ht and  . Hence, the aggregate supply
function is a downward sloping like Curve AS in Figure 3. It should be noted that thevertical axis is the inflation rate  , and not the price level pt . When inflation advances,
the nominal wage, Wt , increases because future goods become expensive relative tocurrent goods. This dampens labor demand because profits become negative if a firm
does not reduce hours worked. Accordingly, the aggregate supply, ytS , decreases as
inflation advances. This is how Curve AS is derived.
The labor productivity  is a vital parameter of the aggregate supply function as shownin Equation (13). Suppose that the hours worked, ht , is kept constant and that the laborproductivity slows downs (  becomes a smaller value than before ). Then, the (ex-ante)
inflation rate,  , decreases and disinflation occurs. The decreased labor productivity
6curtails the aggregate supply, and hence, aggregate consumption must also decrease.
The aggregate consumption of young individuals is an increasing function of  . 4
Therefore,  decreases to equilibrate the goods market. Thus, whenever the laborproductivity stagnates, Curve AS shifts downward.
Let us now consider the aggregate demand, ytD . The aggregate demand comprises three
items: young generation’s consumption; old generation’s consumption; and thegovernment consumption. Young generation’s consumption, c1t , becomesc1t  c    yt ,1  c '  0 ,(14)

because the lifetime utility function on consumption is homothetic. Since the oldgeneration is assumed to have no incentive to pass on inheritance, they exchange the all
their money, which they carried over from the previous period, and thus,

c2t 1 

M t 1pt(15)

holds. The budget constraint of the government is as follows:gt 

M t M t 1

.
pt
pt

(16)

This identity implies that the government finances its consumption by seigniorage.
From Equations (14), (15), and (16), the aggregate demand, ytD , can be defined as

ytD  c    yt 

M t jM t 1M gt  c    yt  m , where m  t , j  0 .
pt
pt  jpt(17)

To find the equilibrium with the zero-profit condition of the firm, we can set

ytD  ytS  yt .

(18)

Using Equation (18), Equation (17) can be transformed intoyt  c    yt  m

 yt 

m.
1 c

(19)

Equation (19) is the equation of the aggregate demand. When the inflation rate increases,
the equilibrium GDP, yt , increases. Thus, the aggregate demand function AD becomesupward sloping. In addition, when real cash balance, m , increases, ceteris paribus, Curve

Here I analyze properties of the aggregate supply curve. However, information on the
demand side of the goods is inseparable from the analysis. This is because the indirect
lifetime utility function, ID , contains information on the demand function.

47

AD in Figure 3 shifts right because of the multiplier effect. Equilibrium of the economy
is achieved at Point EK, which is the intersection of Curves AS and AD .

3 Comparative Statics
This section considers how exogenous economic shocks affect the macroeconomic
equilibrium. Three shocks are analyzed: labor productivity slowdown; radical QE
monetary policy; and stagflation provoked by the lack of belief in the intrinsic value ofmoney.
3.1 Labor Productivity Slowdown
An autonomous labor productivity slowdown is represented by the reduction ofparameter,  . As described in Section 2, this causes a downward shift of the AS curve.
Figure 4 illustrates the consequence. The equilibrium moves from Point A to A1 .
Accordingly, the slowdown of labor productivity and disinflation coexist in our theory.
The causality is as follows. An autonomous labor productivity slowdown decreases theaggregate supply, and excess demand emerges in the goods market. Assume that
individuals are confident of the current intrinsic value of money,

1, then by definition,pt

the current price level, pt , is unchanged 5 . It is plausible to assume that individuals
anticipate the future price, pt 1 , to be lower because the economy will sufficiently adapt
to the labor productivity slowdown. Thus, rational ex-ante deflationary expectations are
generated and disinflation is realized. Such disinflation reduces the aggregate
consumption of the young generation, and hence equilibrates the goods market. It also
should be noted that the economy falls into recession because of the decrease inaggregate consumption.

3.2 Effect of Radical QE Monetary Policy
The radical QE monetary policy shifts the aggregate demand curve AD towards the rightas in Figure 5. The economy moves from Point B to B ' . Business upturns in conjunction
with disinflation.
My model can determine only the relative value of money (the inverse of the inflationrate). It is necessary to determine the value of the sequence of price levels to establish
the initial condition of the price level. This value is arbitrarily given. The condition forʻconfidenceʼis developed by Otaki (2015), which implies that the current absolute

5value of money,1, is independent of the nominal money supply.
pt8This property of the model is quite similar to the current situation faced by the Japanese
economy. The QE policy, which injects a huge amount of money into the economy,
requires the same amount of new demand for money. As Equation (19) shows, aggregate
saving is an increasing function of GDP and a decreasing function of the inflation rate.
Accordingly, GDP increases (the multiplier effect) and the inflation rate is reduced. Since
the aggregate supply function, Equation (13), is a decreasing function of the inflation
rate, an increase in GDP and a deceleration of inflation is consistent with the change on
the demand side.
In other words, the inflation rate must fall to create new demand for money toequilibrate the money market. Disinflation also helps to increase aggregate income
because disinflation lowers real wage per capita in terms of current goods. It should be
noted that disinflation is a phenomenon which increases the rate of return for money.
Money has two aspects: a measure for exchange and its intrinsic value that it holds
within. These social roles of money are inseparable.6 When the rate of return increases,
much money is carried over for future consumption.
Followers of the quantity theory of money forget this fact. Monetarism, including the
new Keynesian’s real cash balance in the utility function, has no microeconomic
foundation for money demand. Many central banks follow the quantity theory. They
believe their economy can escape from disinflation if sufficient money is injected despite
the fact that radical QE monetary policy actually provokes disinflation and/or deflation.
As long as the intrinsic value of money is in a state of confidence, disinflation prevails
despite the intent of the central bank. However, there is no denying that there is indeed
a limit of the nominal money supply where individuals can maintain confidence in money.
Once the volume of the nominal money supply exceeds this critical point, hyperinflation(bust of the money bubble) is inevitably provoked. Details will be discussed in the next
section.

3.3 Stagflation: Bust of the Money Bubble
Bruno and Sachs (1985) regard stagflation as the upward shift of the aggregate supply
curve like AS ' in Figure 2 caused by circumstances as a crude oil price hike.
My model predicts such supply shocks, which aggravates labor productivity, causes
disinflation. Which of the two phenomena is actually realized can only be determined bya precise and careful empirical analysis. While stagflation, which Bruno-Sachs originally6

For a proof on the inseparability of money’s two roles, see Otaki (2015, Ch.15).
9

illustrated, was a temporary phenomenon, most stagflations observed in Greece, SouthAmerican countries, and African countries are actually persistent. Such phenomenon
comes from the lack of belief in the intrinsic value of money.
It should be noted that money belongs to a class of ʻbubbly assetsʼin the sense that
fiat money is an asset which possesses no economic value in itself. However, individuals
believe its intrinsic value to the extent that the circulated money is scarce relative to(i) the potential production capacity of an economy, and;(ii) the levying ability of the government.
Whenever the production level approaches full capacity, the economy has no room forproviding goods for additionally issued money. If either of these two conditions is notsatisfied, individuals tilt lose faith in the intrinsic value of money, which is based on thesocial benefits derived from overcoming the difficulty of the double coincident of wants.
Even money loses its confidence, if conditions (i) or (ii) is not satisfied. That is,
individuals become skeptic whether money can be used to exchange for goods at any
given time.
In such a case, stagflation is provoked in the following way. Individuals rush to thegoods market, and the price hikes rapidly. The real cash balance m 

Mtdecreases. Thispt

shifts Curve AD upwards, and hence, equilibrium moves from Point C to C1 as in
Figure 6.
This implies that the increase in the current price level pt deprives the purchasing
power of the old generation and government, and thus, results in the fall of GDP, yt . Ex-

post stagflation is provoked in the sense of Equation (1). Distinct from the Bruno-Sachs
model, such stagflation, which is triggered by a lack of the intrinsic value of money ispersistent. To offset the reduction of the aggregate demand, the equilibrium inflation
rate stays at a high level because a higher inflation rate stimulates the consumption of
the young generation. In other words, the young generation also loses faith in the valueof money. I have implicitly assumed the policy variable to be real cash balance.
Accordingly, even though the government increases the nominal money supply
proportional to the inflation rate, the economy continues to be stuck in a devastating
economic situation.
As discussed in Subsection 3.2, the radical QE monetary policy is effective to the extent
that individuals are confident of the intrinsic value of money (although the effect on
inflation rate does not satisfy central banks). However, there is a limit in this kind ofmonetary policy. When the real cash balance exceeds the upper bound that might be10

prescribed in conditions (i) and (ii), belief in the intrinsic value of money is impaired, andhence hyperinflation and persistent stagflation will ensue. It is an ironical historical factthat the socialist leader Lenin advocated this is the fastest way to annihilate themonetary system and collapse capitalism.

4 Concluding Remarks
This chapter examined how labor productivity slowdown affects the inflation rate. In
addition, I analyzed the relationship between the radical QE monetary policy and theinflation rate. Findings are as follows.
First, the standard neoclassical model fails to explain the coexistence of the laborproductivity slowdown and disinflation. Intuitively, as the Bruno-Sachs (1985) model
suggests, such a slowdown triggers an upward shift of the aggregate supply curve. Hence,
to the extent that the aggregate demand curve stays intact, the economy falls into
stagnation with an increased equilibrium price. (i.e., static stagflation, which implies theoccurrence of a one time jump of current prices).
Second, in contrast to the neoclassical model, the Keynesian OLG model predicts thata labor productivity slowdown triggers disinflation. The causality is as follows. A laborproductivity slowdown curtails aggregate supply. Whenever individuals are confident of
the intrinsic value of money, by definition, the current price remains at the same level,
and thus, excess demand emerges. Individuals rationally anticipate that the economy
will adapt to the productivity slowdown, and reduce the potential excess demand, andhence, expect the equilibrium future price level to be lowered relative to the current level.
As such, disinflation occurs. Since the consumption demand of the young generation isan increasing function of the inflation rate, disinflation curtails the current aggregate
demand. Through this process, the equilibrium of the overall economy is achieved.
Namely, I ascertain the causality by which the slowdown in labor productivity isconnected with disinflation.
Third, I have ascertained that the radical QE monetary policy advances disinflation.
The radical QE monetary policy has two aspects. One aspect is that real cash balance isdrastically increased as long as confidence in money is retained. The rate of return formoney (the inverse of the inflation rate) increases to equilibrate the money market (thereverse side of the goods market), and thus, disinflation advances. The other aspect isthat the increased real cash balance expands the aggregate demand, and recovers thebusiness through the multiplier process. Accordingly, business booms and disinflation
coexist under the radical QE monetary policy, as long as individuals retain confidence .
11

Finally, I clarified how persistent stagflation is provoked by a lack of belief in the
intrinsic value of money. As discussed above, the Bruno-Sachs (1985) model describes
stagflation as a transition process caused by a supply shock such as crude oil price hike.
A negative supply shock shifts the aggregate supply curve leftward. As a result, price ofgoods price also hikes and the equilibrium GDP decreases. Nevertheless, their model isbasically static, and the hike of the output price is temporary. Actual stagflation provokes
more persistent inflation along with mass unemployment. In fact, most developing
economies are burdened by this kind of structural stagflation. Lack of belief in the
intrinsic value of money is considered to be provoked by the following two conditions:(1) a huge amount of money stock relative to an economy’s potential production capacity,and;(2) an inadequate levying ability of the government.
If either condition (1) and/or (2) is satisfied, individuals become skeptical about theexchangeability of money for goods. Consumers are confident of the intrinsic value ofmoney, which stems from the convenience factor as a means for exchange, and/or its
value hoarding nature. When either condition (1) and/or (2) threatens the repayment
ability of the government, individuals regard such a situation as the bankruptcy of thegovernment. Individuals rush to the goods market and the price level hikes. This reduces
the purchasing power of the old generation and the government whose income is fixed in
the nominal term, and hence, aggregate demand decreases. Potential excess supply
emerges. Thus, the economy falls into a serious stagnation. In addition, the young
generation rationally expects that the economy would adapt to such a devastating
situation, and that the equilibrium future price level would continue to be high clearing
the potential excess supply. Thus, lack of belief in the intrinsic value of money provokes
stagflation.
To summarize, there is a critical limit in the radical QE monetary policy. The criticalpoint is determined by whether conditions (1) and/or (2) are satisfied or not. It should be
noted that hyperinflation is a kind of stagflation in the sense that economic stagnation
and rapid price increase coexist. As discussed above, lack of belief in the intrinsic valueof money is persistent once it is generated. This is the reason why prudent management
is the most important virtue for traditional and conservative financial institutions. This
still seems to be a conventional wisdom today’s the current financial institutions.

12References
Bruno, Mickle and Sachs, Jeffery (1985). Economics of Worldwide Stagflation,
Cambridge Massachusetts Harvard University Press.
Byrne, David M., Reinsdorf, Marshall B., Fernald, John G.. (2016). Does the UnitedStates have a Productivity Slowdown or a Measurement Problem? Federal Reserve Bankof San Francisco Working Paper, 2016-03.
http://www.frbsf.org/economic-research/publications/workingpapers/wp2016-03.pdf
Christensen,Jens (2009). Inflation Expectations and the Risk of Deflation, FRESF
Economic Letter, 2009-34.
http://www.frbsf.org/economic-research/publications/economicletter/2009/november/inflation-expectations-risk-deflation/
ECB Economic Bulletin, Issue 2 / 2016 – Box 1 (2016). The Slowdown in US Labour
Productivity Growth – Stylised Facts and Economic Implications.
https://www.ecb.europa.eu/pub/pdf/other/eb201602_focus01.en.pdf?251945eddd1eeb95a
2a7ba99c6e11ca9
Galli, J. (2008). Monetary Policy, Inflation, and the Business Cycle: An Introduction to

the New Keynesian Framework, Princeton, New Jersey, Princeton University Press ,Lucas, Robert E., (1972). Expectations and the Neutrality of Money, Journal of Economic
Theory 4, 103-124.
Otaki, Masayuki. (2007). The Extended Keynesian Cross and the Welfare Improving
Fiscal Policy, Economics Letters 96, 23-29.
Otaki, Masayuki (2009). A Microeconomic Foundation of the Full-Employment Policy.
Economics Letters, 102, 1-3.
Otaki, Masayuki (2015). Keynesian Economics and Price Theory: Re-orientation of a
Theory of Monetary Economy, Tokyo, Japan, Springer.
Piazza, Roberto, Deflation Expectations and Japan's Lost Decade (June 25, 2015). Bankof Italy Occasional Paper No. 274.
http://dx.doi.org/10.2139/ssrn.2649915
13

Year

Labor Productivity Progress (%)

Inflation Rate (%)

2001

1,7

3.6

2002

1.7

2.7

2003

2.3

2.4

2004

2.2

2.6

2005

1.6

2.6

2006

1.5

2.5

2007

1.4

3.6

2008

-0.1

0.51

2009

0.3

1.8

2010

1.8

2.9

2011

1.3

2.2

2012

0.3

1.6

2013

1.1

1.7

2014

0.6

0.6

2015

0.9

1.1

Table 1: Labor Productivity Progress and Inflation Rate
Data Source: OECD Employment and Market Statistics

14

G(h)

E
γ
O

h
Figure 1 The Static Case

15

pW
DD

E1

SS
E

O

Figure 2 Neoclassical Equilibrium

16

y

ρ

AD

EK
AS
O

y
Figure 3 Dynamic Equilibrium

17

ρ

AD

A
A1

AS
AS ′

O

y
Figure 4 Productivity Slowdown and Disinflation

18

AD

ρ

AD′

B

B1
AS ′
O

y
Figure 5 Radical QE Policy and Macroeconomy

19

AD′′
AD

ρ

C1

C

AS ′
O

y
Figure 6 Stagflation by Disbelief in the Value of Money20