1

The Deflationary Gap in Japan, 1970-2000: A Quantitative Measurement

1. Orthodox Concept versus “False” Concept of Deflationary Gap
In Japan, from 1970 to 2000, the fixed capital stock of private enterprises (EPAJ’s data,
all sectors) expanded by 8.1 times in real terms and the number of unemployed persons
increased by 5.4 times, while the real GDP increased by merely 2.6 times, industrial production
came to a halt as indicated by the mere 2.2 times’ increase, during the same period. 1 Seeing
these simple statistics, the recent deflationary gap (or GDP gap) in the economy of Japan isundoubtedly very large. However, if we inappropriately give a definition to the concept of‘deflationary gap’ as the temporal downward deviation of real GDP from its average trend line,
the size of such a ‘deflationary gap’ would appear to be rather small. Unfortunately, the White
Paper series of EPAJ (Economic Planning Agency of Japanese Government) in the 1990s
depends on the questionable concept of ‘deflationary gap’ (or GDP gap), so that its estimatedvalues of the gap were very small, only a few % for every year, during the later half of 1990s,
and then its analyses have been very misleading.2 For the estimation of the average trend line,
EPAJ uses the production function. It seems, it would be too pedantic. A mere free-handdrawing would be enough and it could yield similar estimated results. Any way, properly saying
from the standpoint of common sense of economics, such a very small-size deflationary-gap
would mean extremely heated situations of boom, while the actual state of things of Japan in
1990s was a worst slump. From the beginning of 2001, EPAJ has been incorporated to Cabinet
Office of Government. Though the estimating method of ‘deflationary gap’ (or ‘GDP gap’) has
been changed a little, however, in so far as the first new White Paper edited by the Cabinet
Office (published in Dec. 2001) is concerned, the computed results and its shortcomings arealmost same to the former calculations by EPAJ (see Supplement below).
As shown in Graphs 1, 2, 3 and 4 below, the computed results of statistical-quantitative
measurement by the our study clearly indicate that, since the 1st half of the 1970s to the present
time, in the Japanese economy, such an average trend line of actual real GDP as cited above
itself has been deviating below from the potential ‘full-employment and full-utilization ceiling’of productive capacity by a large margin. There has been a long-lasting tendency of

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ever-diverging difference between both real-term trends of actual GDP and potential
full-capacity GDP. It should be regarded that the divergence is the deflationary gap in a widely
accepted orthodox sense. 3

2. Unreliable Data Compilation in EPAJ’s White Paper
For the EPAJ’s estimate of production function cited above, the data for capital inputs rely
upon the index of capacity utilization of fixed capital stock in the manufacturing industry
calculated by MITI (Ministry of International Trade and Industry). Namely, the index ofenterprises’ real fixed capital stock estimated by EPAJ has been multiplied by the MITI’s index
of capacity utilization.
. However, it should be noted that the reliability of the MITI’s index is very questionable.4
The index has been computed from only 150 sample items of rather old-type traditionalcommodities of mostly mature and stagnant industries (in case of ‘1985 base’ index), so that it
is not sensitive to trade cycle and economic changes. It appears that the MITI’s index always
tends to underestimate the magnitude of not only fluctuations but also long-term changes on
capacity utilization as a whole.5
Worse still, the EPAJ’s estimation studies of production functions made no allowance forany changes in the capacity-utilization-ratios of capital inputs in any sectors other than the
manufacturing industry.6 In other words, EPAJ had always assumed the full-utilization of fixed
capital stocks in all sectors other than manufacturing. It would be very unrealistic assumption.
Consequently, the EPAJ’s estimation procedure entails a strong upward bias in the trend of
capital input data. If we base our estimates on the EPAJ’s procedure of data compilation, we
would get the computed results shown in Table 1.
As is well known, the Japanese performance in building up high-technology sectors ofindustry was quite remarkable during the 1970s and 80s and the consequent rate oftechnological progress was actually splendid. Nevertheless, the computed rates of productivity
increase of aggregate inputs ( i.e., the Solow’s residual ) shown in Table 1 are very low, i.e.,
0.15 – 0.17% per annum, or virtually nil, during 1970-93. (The year,1993, was the final year for
many important series of official real term indexes at 1985 prices; so that we must rely on somelinked indexes, mostly linked with indexes at 1990 prices, for the period from 1993 to the

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present.)
As discussed in Section 6, when we tried to adjust the imputation of the incomes of the
not-incorporated small private enterprises, the aggregation weights were altered to 0.42 forcapital and 0.58 for labor, while the original weights derived from the official national income
accounts (GDP accounts) for 1985 were 0.456 and 0.544. However, the consequent changes in
the obtained results by the use of ‘adjusted weights’ are trivial as cited in the note to Table 1. In
this case, the computed average rate of technological progress is 0.38% per annum during theperiod of 1970-93. Though the adjusted value of technological progress is slightly higher thanoriginal computation, it is still too small, i.e., only 1/ 10 of the actual growth rate of real GDP.
The very small value would also be far from the reality.
In Japan, these two decades (1970s and 80s) were also an era of remarkable structuralchange in the manufacturing sector from capital intensive ‘big plant industry’ to knowledge
intensive ‘light-thin-short-small goods’ industry. There were no necessary conditions for large
increases in the ‘required capital / output ratio’. Contrary to this, Table 1 shows a very large
increase in ‘required capital / output ratio’. Needless to say, the calculations cited in Table 1 areextremely unrealistic. These computed results surely have come from the above-statedupwardly biased data for capital inputs. Therefore, the estimation research by the author himself
has had to work out in the present study without using the official ‘index of capacity
utilization’.

3. Conventional Estimating Methods for Production Functions and its Shortcomings
Probably the most common procedure for estimating the parameters of a production
function, especially in the case of widely used Cobb-Douglas type function, would be comefrom multiple regression measurements by the method of least squares. However, it seems, theconventional method is subject to serious shortcomings due to some effects ofmulticollinearity.7
Fundamentally speaking, as widely shown in many text books for econometrics, a basic
prerequisite for stochastic function estimated by conventional multiple regression method is that
there must be no inter-correlations among regressors. In the estimating works for production
functions by multiple regression procedures, in so far as we use time-series data, we should

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expect a very high multiple inter-correlations among three regressors, i.e., capital, labor andtime-trend. In such cases, even in the case of a seemingly good fit in which the calculated valueof R2-coefficient is high and t-values for the estimated parameters are also acceptable, wecannot easily escape the consequences of multicollinearity, i.e., the estimated regression
coefficients must be largely distorted and unreliable.
Basically speaking, the regression coefficients for labor and capital in a estimated
Cobb-Douglas type production function, would be merely an indirect approximation to therelative proportions of earnings of both production factors. However, in case especially we use
the data of time-series samples, the values of these coefficients are uncertain, and consistency of
the regression coefficients with the relative proportions of each factor’s earnings in national
income accounts may be lost, because of the effects of multicollinearity. On several occasions,
it would be responsible forintolerable distortions in the computed results of some important

policy-simulation analyses. Therefore, when we can find out more reliable actual value of therelative proportions of factors’ earnings from official national income accounts, this value
should have priority of usage. The series of EPAJ’s White Paper in 1990s mostly ignores thisprinciple of priority in its estimates of production functions.8
In this regards, it should be called to mind that the well-known studies by Edward
Denison(1974), Abram Bergson(1963), Richard Moorsteen and Raymond Powell(1966) andothers to measure increases in productivity of aggregated inputs without use of the methods ofmultiple regression estimates of production functions provide a means to avoid theshortcomings of stochastic production function approach.9

After due consideration of theabove-stated shortcomings, the author chooses to give up the idea of using the method ofmultiple regression estimates of a production function. Then, in the present study, the author has
tried to contrive an alternative way for measurement of deflationary gap.

4. “Natural Rate of Unemployment” versus “Full Employment”
In this study, a way of doing of substitution with the some employment level corresponded
to the ‘natural rate of unemployment’ in stead of ‘full employment’ is not adopted.
One reason for it is that, considering by the neo-classical way of thinking, any ‘natural rateofunemployment’ is always bound to be very closely resemble to actual rate of

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unemployment, as a basic theorem. Therefore, substituting with the employment level under theconditions of ‘natural rate of unemployment’ to the ‘full employment’ level means any
deflationary gap would be negligible at all times. Or, if we assume some definite ‘natural rate ofunemployment’ continuously has considerable differences from actual unemployment rates, inthe middle or long run, as not shorter than several years, it is conceptually inconsistent with thebasic theorem cited above.
Another reason is that, as minutely analyzed in a previous paper written by the author, theLucasian ‘aggregate supply function’ ( i.e., ASL/LAS ) andrelated derivation of‘naturalrate of unemployment’ is based on a rigorous presumption of no-change in the rate of operationof enterprises’ fixed capital stockand related no-shift (in real terms) of short term production

function.10 Of cause, such an assumption is extremely unrealistic and implausible for any
actual policy making economics. Needless to say, the upward changes in the rate of operation of
fixed capital stock would be took place due to some augmented demands, and it might induce
some shifts of production function in real terms, bringing about increases in productivity andprofits. As shown by the author in the previous paper, under the generalized conditions
reckoned with the effects through such

shifts of production function, Lucasian LAS is notvertical but rather flat and the value of ‘natural rate of unemployment’ turns into be flexibly
changeable, corresponding to changes in total demand. In sum, in the actual world under thegeneralized conditions, Lucasian ASL/LAS and ‘natural rate of unemployment’ are become tobe consistent with the most Keynesian policies.11

5. Estimating Procedure in the Present Study
The estimating procedure in this study is composed of five steps as follows:〔Step 1〕Computation of the aggregate ‘full capacity inputs index’, i.e., ‘full employment& full utilization index’ of labor force and enterprises’ real fixed capital stock:
Here, it is operationally assumed that the rate of employed labor force and average weekly
hours worked per head of employed persons in 1970 are practically equivalent to the conceptual
conditions of ‘full employment’. Hence, it can be assumed that the rate of change in the
full-employment level could be regarded as identical with the rate of change in the actual levelof total labor force.

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Of cause, we can alternatively use, for example, the rate of employed labor force andaverage weekly hours worked in 1990 as the conceptual conditions of full employment. To tell
the truth, the author himself actually tried to work out such an alternative computation based onthe ‘1990 standard’. However, the computed results are rather disappointing, because, for the
every year up to 1990, the ‘full employment labor force’ by this alternative concept has been
computed as lower than actual employment level. Needless to say, the concept of ‘full
employment’ means the potential maximum of mobilize-able labor force. Therefore, the author
had to consider that such an alternatively computed result with ‘1990 standard’ might be quite
implausible.
For capital inputs, it has been made use of the EPAJ index of enterprises’ fixed capitalstock in all sectors (in real terms at 1985 prices) as the indicator. The Economic ResearchInstitute of EPAJ urged that the index of enterprises’ real fixed capital stock (in terms of ‘gross’
concept subtracted with the acquisition cost of worn out and abandoned assets) should be
regarded as a good indicator for the productive capability of capital plant.12
The aggregate ‘full capacity inputs index’ in real terms at 1985 prices (as particularly
shown in Appendix Table 1 below) has been consistently computed by a weighted geometricmean formula with ‘1985 weights’ as the relative proportions of earnings of both production
factors (i.e., labor and capital) which have been derived from the official GDP accounts. The
relative shares of factors’ earnings were very stable during the period of 1975-95.13 In Sections
6 and 7, the probable adjustments of the weights and its consequent results are discussed.
Any way in this our study, the computation procedure stated here does not rely to multiple
regression method for estimation of production function, and so, it does not need to use MITI’s
operating ratio index.

〔Step 2〕Experimental-exogenous setting of the δ ratio:
The definition of δ, which is the ratio of the rate of technological progress to the rate of
economic growth, is as follows:δ =yearly rate of technological progress(%) / yearly growth rate of real GDP (%)

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Here, the meaning of ‘technological progress’ is not the ex-post value of‘Solow’s residual’(inclusive of some effect from idle capacities) but the ex-ante pure concept (excluding theidle-capacity effect).14

During the ‘high-speed growth era’ of the 1950s and 60s, the δ ratio

in the Japanese economy was approximately 1/2.15 However, it seems, the δ ratio was asomewhat smaller value in the 1970-2000 period.16

For the simulation work in this study, fourcases of the value for δ ratio have been experimentally assumed as 1/3, 1/3.5,

1/4

and

1/5.

〔Step 3〕Computation of the indexes of ‘full capacity GDP’ and ‘required capital / output
ratio’:
According to the procedures Step1 and Step2, we can work out some series of yearly
growth rates of ‘full capacity GDP’ (in real terms at 1985 prices) which could be produced by‘full employment and full utilization’ of labor force and fixed capital stock, corresponding toeach givenδ ratio respectively, as

growth rate (%) of real ‘full capacity GDP’
= growth rate (%) of aggregate ‘full capacity input’ / (1 -δ).

Of course, the indexes of the level of ‘full capacity GDP’ can also be computed with easeas the link series of these growth rates (see Table 2 and Appendix Table 2).

In the initial value

adjustment for the indexes, it is operationally considered that a deflationary gap as low as 3% ispractically equivalent to the economic situation of ‘full employment and full utilization’ oflabor force and fixed capital stock.17

At the same time,the indexes of‘required capital /output ratio’ corresponding to each δ can be also computed.

〔Step 4〕Measurement of deflationary gap:
From comparisons of the calculated indexes of ‘full capacity real GDP’ with the index of‘actual level of real GDP’ (at 1985 prices), we can easily identify the sizes of the annual
deflationary gap in the Japanese economy (see Tables 2(A), 2(B), Appendix Table 2 and Graphs
1, 2, 3 and 4 ).

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6. Computation by Adjusted Weights
In the official national income accounts, the income of private not-incorporated small
businesses are counted as one portion of the ‘enterprises income’, that is mostly classified as the‘operating surplus’ of businesses. In other words, it has been officially treated just as that theemployees’ compensations are not included in it.

However, there may be some possibilities

that it is better to impute a part of such income of not-incorporated private small businesses tothe ‘compensations of employees’.
Based on such thinking, in this study, I have tried to adjust the weights for aggregation offactors’ inputs and to do computations by it. . The derived ‘adjusted weights’ are 0.58 for laborand 0.42 for capital (the detailed procedure of derivation and sources for it is shown in Footnote
18 ).18
The results of computation by the use of the ‘adjusted weights’ are summarized for 1995
and 200 in Table 2(A) ( line (b) ). As cited in the table, though the values of deflationary gap
computed by ‘adjusted weights’ are slightly smaller than the results of the original computation(as shown on line (b) of Table 2(A), we must consider that the deflationary gap in recent Japan
would be around 30-45% of the potential full-capacity GDP, in case we stand on the ground of
the adjusted computation. Of course, it is also big. The long term trend of the deflationary gap,
1970-2000, computed by the use of the ‘adjusted weights’ is shown in Appendix Table 2 andGraph 2.

7．Computations based on GDP at Factor Cost
All the aforementioned measurements of deflationary-gap have been based on real GDP
account at market prices (i.e., at ‘1985 constant market prices’). An important alternative would
be another set of similar computations for real GDP at factor cost. In the present study, thealternative computations also have been worked out
In the first instance for it, a series of real GDP at factor cost was derived through subtractionsof indirect tax net of subsidies in real terms from the series of real GDP at market prices.19 Then,aggregation weights for inputs of factors of production, labor and capital, have been calculated
from the GDP account at factor cost for 1985: i.e., 0.58 for labor and 0.42 for capital.20
In case the adjustments for imputation of the incomes of small not-incorporated private

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enterprises applied to the factor cost GDP, the derived adjusted weights are 0.62 for labor and0.38 for capital.21
The calculated results of deflationary-gap and increases in required capital/output ratio
based on the factor cost GDP for 1995 and 2000 are shown in the Table 2(B).

The computed

values of deflationary gap are 26.1 ‑41.1% for 1995 and 31.3-46.5% when the original weights
were used, and 19.8 ‑35.2% for 1995 and 24.8- 40.5% for 2000 in case the adjusted weights
are applied. However, if we assume the probable limitation to changes in required
capital/output ratio might be around 1.7-1.8 times increase from 1970 to1995 as discussed
below, the realistically meaningful values of deflationary-gap would be 31.5-41.1% for 1995
and 36.8-46.5% for 2000 in the case with ‘original weights’ and about 35 % for 1995 and 40%
for 2000 in the case with ‘adjusted weights’. Of cause, these computed values ofdeflationary-gap based on factor cost GDP are also not so small.

8. Computed Results
The computed results of deflationary gap in Japan for 1995 and 2000 by the above-statedestimating procedure are summarized in Table 2 (A) and Table 2 (B). And its long term trends
from 1970 to 2000 are shown in Appendix Table 2 〔1〕〜〔4〕and Graphs 1〜4 cited below.
Here, it should be noted that, in the cases where the value of δ is rather high (e.g. 1/3 or
1/3.5), the increases in the ‘required capital / output ratio’ are relatively small. However, incases where the value of δ is rather low (e.g. 1/4 or 1/5), the ‘required capital / output ratio’shows relatively large increases. In sum, larger increase in ‘required capital / output ratio’
entails smaller rate of technological progress.
As cited above, during the two decades of the 1970s and 80s, technological progress inhigh-tech sectors of Japanese industry was obviously excellent as a historical fact. At the sametime, in Japan, these decades ( i.e., 1970s and 1980s) were also an era of remarkable structuralchanges in the manufacturing branch for shifting from capital intensive ‘big plant industry’ toknowledge intensive ‘light-thin-short--small-goods’ industry. In so far as any effects of idle
capacity arising from insufficient total demand were conceptually excluded, there were no
definite reasons for large increases in ‘required capital / output ratio’ for the manufacturingindustry of Japan in those days. As calculated in Table 1, in case we strictly follow to the

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EPAJ’s data compiling, a very large increase in the ‘required capital / output ratio’ as 2.3 times
during 1970-93 entails extremely small rate of technological progress as 0.15 % per annum,
that is virtually nil. Seeing carefully the computed results in Table 1, we must recognize that thecalculated rate of increases in ‘required capital / output ratio’ larger than 2 times during theperiod from 1970 to the first half of 1990s would be too unrealistic and implausible. It seems,
the plausible limit to the increases in ‘required capital / output ratio’ would be around 1.7-1.8
times for the same period. Therefore, a value such as δ = 1/5 would be an underestimate of
the economic efficiency of Japan. Even a value of δ = 1/4 would still tend to underestimate
Japan’s economic performance. In the light of the computed results, cited in Table 2 (A) andTable 2(B), we must conclude that the deflationary gap in Japanese economy in the middle of
1990swould amount to around 30-45 % of the potential full-capacity GDP. The gap values

for 2000 would be 40-50% as cited in Tables 2 (A) and 2(B). It is quite large.

9. A Replying Comment to the Criticism by Professor Sato
However, Kazuo Sato criticized the calculations of this study presented in the author’s
previous paper as the experimental-exogenous setting of the values of δ ratio for simulation
work entails some arbitrariness.22 Here, in this regards, as a replying comment to Sato, theauthor has to stress that, we must carefully watch two check points for any estimating study of
deflationary-gap. The one is the computed rate of increase in required capital/output ratio
which is exclusive of idle-capacity effect. The other check point is the value of the implied rateof technological progress, namely the ‘Solow’s residual’ as an ex-ante pure concept excluding
ex-post idle-capacity effect. Needless to say, values of δ ratio are nothing but the good
synthetic indicator for the rate of technological progress. As described fully in this paper above
and in previous paper written by the author too, in every case we get the computed results ofrather smaller sized deflationary-gap as below than around 25% as for recent Japanese economy,
the rate of technological progress and the rate of increases in required capital/output ratio could
not be plausible values.

In this study, the author has very carefully watched the two checkpoints and has been obliged to consider that, for the period from 1970 to 1995 in Japan, thepermissible limit of the calculated rates of increases in required capital/output ratio would be
about 1.7-1.8 times as cited above. It means that the value of δ ratio as 1/5 would be- 10 -

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inappropriate due to some underestimations of technological progress, in case the calculations
by ‘original weights’ for real GDP at market prices . In the same meaning, as shown in Table 2(A), the values of δ ratio as 1/5 and 1/4 would be implausible for the computations by‘adjusted weights’ for real GDP at market prices.

As for the computations based on factor cost

GDP, with similar considerations, the values of δ as 1/5 and 1/4 should be treated as
inappropriate, in case of using ‘original weights’. Similarly, values of δ ratio as 1/5, 1/4 and1/3.5 could not be permissible for calculations based on factor cost GDP by ‘adjusted weights’(see Table 2(B)).

It must be afraid that the estimated results of deflationary gap for recent

Japan computed by many economists other than the author himself could not clear to do pass
the very important two check-points cited here.

10. On the Okun’s Law
As widely known, the empirical finding by Arthur Okun about US economy was that e.g.1%
decrease in the rate of unemployment ( i.e., 1% increase in the rate of employment), bringing onsome increases in participation ratio and average hours per head of employed persons, would
result in around 2% growth of total labor inputs in terms of total annual worked hours. Then,such 2% increase in total labor inputs would bear 1% rise of labor productivity. So, ultimately, it
would bring forth 3% growth in GDP.23
That is to say, when we denote the ratio of ‘rate of increase in labor productivity (%) /growth rate of real GDP (%) ’ as symbol θ, Okun’s finding can be summarized asrate of real GDP growth (%) = rate of increase of total labor inputs (%) / (1‑θ) .

As cited above, according Okun’s study, the value of θ in US economy in 1960s was around1/3. However, in the economy of Japan during 1980s and 1990s, the θ ratio has had rather
higher values as 0.75 for 1980 → 1990 and 0.83 for 1980 → 1995.24
The ratios of ‘full-employment total labor inputs/actual total labor inputs’ (in terms of
total worked hours) in Japan are 1.0653 for 1990 and 1.1331 for 1995.25 Hence, the probableincreases (%) of real GDP, when full employment has been achieved, could be calculated as
26.1% (= 6.53 ÷ (1 ‑ 0.75) ) for 1990 and 78.3% (＝13.31 ÷ (1 ‑ 0.83) ) for 1995 .

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This calculation, too, is an approach to the estimation of deflationary gap through another way
by the use of ‘Okun’s law’: namely the calculated deflationary gap is 20.7%(=

1‑(1÷1.261)〕×100 ) for 1990 and 43.9% (=〔1‑ (1÷1.783)〕×100 ) for 1995 . It seems,
the computed values of ‘deflationary gap’ are also rather big, despite the calculation dose notinclude the effects of induced increases of ‘participation ratio’.
Though Okun’s such method is mere empirical rough approach, the calculation shown above
suggests that the sizes of recent deflationary gap in Japan cited in Tables 2(A) and 2(B)computed by the author in this study would be not overestimate but rather plausible.
If we substitute some employment level corresponding to any ‘natural rate of unemployment’
instead of the full employment, the calculation by the Okun’s method would result in somewhat
smaller size value of deflationary gap than above.26 However, as particularly argued in Section
4 above, the author cannot approve to do such procedure.

11. Conclusion
The theoretical framework in the study is quite clear and widely acceptable. All thecomputations in the study relied upon the standard database of the official statistics of Japan.
Any artificial alteration or modification to the official statistical data was avoided except for thederivations of the ‘adjusted weights’ in Section 6 and of the GDP account at factor cost in
Section 7. Of course, some kind of upward or downward biases may be more or less involved inthese official statistical data. However, the wide range of the exogenously assumed values of δ
for simulation may be able to make up for the large portion of the distorted effects of suchbiases.
In either of the computations by the use of ‘original weights’ or ‘adjusted weights’, asshown in Tables 2(A), 2(B), Graphs 1〜4, and Appendix Tables 2〔1〕〜〔4〕we see that the
deflationary gap in the recent Japan is very large. In view of the aforementioned considerations,
it seems, there would be little doubt about it.
Finally, as have been aforementioned in the author’s previous paper, the very important
two findings in this study should be noted here again.27
1.

As indicated in Graphs 1〜4, even in 1990, the peak year of the ‘bubble’ period, thedeflationary gap in Japanese economy did not diminish out. Its reason would be rather easily- 12 -

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conceivable because the average yearly growth rate of real GDP during the ‘bubble’ period(three years from 1988 to 1990) was 5.2 %, while the average rate of real GDP growth in the
period of 1973-87 (fourteen years from 1974-87) was 3.6 % per annum.2８ As is widely known,
1973 was the final year of the high-speed growth era in Japan. The growth rate of 3.6 % perannum during 1973-87 was about 1/3 of the average yearly growth rate in the 1950s or 1960s.
Owing to the drastic decline in the growth rate, we have to be obliged to consider, a large
deflationary gap was appeared during the 1970s and 80s. In the ‘bubble’ period, the expansion
in total effective demand for currently produced goods and services was not so large despite
various speculative activities, so that the increase in the growth rate of real GDP was mere
1.6 % per annum (5.2 -3.6 = 1.6). And that it continued for only three years. Therefore, thedeflationary gap did not diminish even in the ‘bubble’ period.
2.

As shown in Graphs 1〜4, the successive breeding of deflationary gap in theJapanese economy was not a cyclical phenomenon but a long-term cumulative trend. On the‘supply side’ of the recent Japanese economy, there are seemingly no serious barriers to theeconomic growth, because the potential GDP in real terms is much larger than the actual realGDP. Therefore, the cumulative tendency of deflationary gap has come from the ‘demand side’,i.e., from the long continuing stagnant trend of total demand. On the basis of the computed
results of this study, it should be estimated that, since the first half of 1970s to 2000, the loss oflost potential real GDP in Japan resulting from the cumulated deflationary gap would
approximately be 4000 trillion yen (at 1990 constant prices; in the case of calculation with‘original weights’ and simulation by δ= 3.5). It is quite huge value. In current day Japan, somepolicy to sharply bend up the long lasting trend of stagnant total demand is urgently needed.

Supplement:
A Critical Comment on the Computations by Cabinet Office of Government
As mentioned above in Section 1 of the text, EPAJ has been incorporated to the Cabinet
Office of Government since 2001. Then, some alterations were made to the method for
estimation of ‘deflationary gap’ (or ‘GDP gap’).29
In the new method, the Cabinet Office has tried to compile and apply some capacity
utilization index for other sectors than manufacturing industry. For the estimation of production- 13 -

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function, the calculating procedure of multiple regression measurements was left off. Throughthe new system, the ‘deflationary gap’ has been calculated as the downward deviation of GDP
from not the simple ‘average trend line’ but the ‘potential GDP level’.

These changes might

be some methodological improvements.
Unfortunately, however, the Cabinet Office has calculated the ‘potential GDP’ as
extremely low level which is practically same to the simple average trend line. It seems, theimplausible result would be attributable to four reasons as follows:
Ⅰ．The Cabinet Office’s calculation depends upon extensive use of capacity utilization index
for fixed capital stocks. As cited above, Cabinet Office tried to compile new index of capacity
utilization for non-manufacturing sectors. It would be understandable as an improvement. Evenso, however, official MITI’s (or METI’s) index of capacity utilization for manufacturingindustry, any way, has serious shortcomings as discussed in Section 2 of the text. Because of
insufficient sensibility of the MITI’s (or METI’s) index of capacity utilization to recession or
slump, any extensive use of it by Cabinet Office would inevitably breeds some underestimatesof idle-potential capacities in depression days.
Ⅱ．

In the Cabinet Office’s calculation, the potential level of capacity-utilization for fixed

capital stock has been decided through some empirically estimated function for the capacity
utilization index with definite value of ‘DI index’ (which is compiled by Bank of Japan) as theregressor.30 However, during the past decade, all values of the ‘DI index’, even its peak values,
were always corresponded to very low growth rate of GDP. This fact might also surely be very
important cause for underestimation of the size of idle-potential capacities.
Ⅲ．

For the calculation of aggregate inputs, the Cabinet Office has applied the value, 0.33,

as the weight for capital input. The weight value is extremely small and inconsistent with the
GDP account’s data at market

prices.3１ As stated above in the Section 4 and footnote to Table

1 in this paper, the ‘1985 weight’ for capital input derived from the official GDP account at
market prices as 0.456 (original weight) or 0.42 (adjust weight). The relative share of capital’s
earnings occupied in GDP at market prices has been very stable during past three decades since
1970s ( see Footnote 13 ). It seems, the weight, 0.33, which is used by Cabinet Office is derived
from some transformed GDP account at factor cost. However, Cabinet Office applied this weightto the production function for real GDP not at factor cost but at market prices. It would be a

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gravely inconsistent procedure.
Ⅳ． The Cabinet Office estimated the unemployed ratio (excluding frictional unemployment)in recent Japan as 0 % or as only a little less than 1 %.3２

In other words, research staffs of the

Cabinet Office have analyzed the economic conditions of Japan during 1990s and 2000-2001 as
full employment situation. Of course, it would be extremely unrealistic thinking. Undoubtedly,such a mistake is due to some incorrect calculating formula. Cabinet Office uses a stochastic
function estimated by multiple regression method, in order to calculate the sizes of totalandfrictional unemployment. For the function, ‘vacancy rate’ of jobs in labor market is treated as
main regressor and the estimated size of unemployment attributed to the regressor is regarded as‘frictional unemployment’.

By the subtraction of it from the estimated total unemployment, as

the residual, the size of deflationary unemployment is computed. However, needless to say, such‘vacancy rate’ is an indicator not only for frictional miss much in labor market but also very
important indicator for macro deflationary-inflationary situations. Therefore, by the use of sucha calculating method, the computed volumes of ‘frictional unemployment’ would be largely
exaggerated and ‘non-frictional-deflationary unemployment’ inevitably underestimatedextremely.

Footnote:
1)

For the official governmental statistics of enterprises’ fixed capitalstock and real GDP index, see Appendix Table 1 and footnote to Table 2(A) andTable 2(B) below. For the unemployment data and index of industrial production, see
Cabinet Office (2001, p. 267 and p. 264).

2)

See, for instance, EPAJ(1994, pp. 145-147), EPAJ (1998, pp. 146-147 andpp.429-430) and also see EPAJ(2000, pp.250-252 and pp.380-381). In the case of recent
US economic performance, it is also possible that the policy makers

tend tounderestimate the potential GDP of US, as analyzed in the paper by Klein and Kumasaka(1995, pp.3-19). However, even in the comparison with it, it seems that the baneful
influence of faulty methodology by EPAJ is extremely serious in its official estimates ofJapanese potential GDP. See a comment by Noguchi in Harada & Iwata (ed.) (2002, pp.

- 15 -

16

21-25).In this regard, a critical comment by Yoshikawa on the Lucas’s work (1987) isvery suggestive. See Yoshikawa (1998, pp.7-9). See also Fair (1989, pp.104-105).

3)

As for the widely accepted truthful concept of ‘deflationary gap’ (‘GDP gap’ or‘GNP gap’), for example, see the famous textbook of macroeconomics by R. Dornbuschand S. Fischer (1978), Chapter 1. And see also the author’s previous works, Niwa (1995,
pp.65-102) and Niwa & Special Committee of SCJ (1996, pp.37-58). See especially Niwa
(2000, pp.245-258) and Niwa (1999, pp. 313-344).

4)

See Niwa (1995, op. cit., footnote 1, p. 68).

5)

The value of the MITI’s capacity utilization index for 1993, comparedwith the level in 1970, was 0.82 (1970=1.0). See EPAJ(1993), Handbook of
Economic Statistics, 1993, p. 17, and EPAJ(1993FY), Japanese Economic
Indicators Quarterly, No.4, April 1994, p.52. During the same period of
1970-93, the actual increase in manufacturing production in Japan was
twofold. Therefore, it seems we ought to consider that the level of productive
capacity in Japanese manufacturing industry should be increased by about
2.4 times (= 2 times÷0.82) from 1970 to 1993. ( The year, 1993, was the final
year for many important series of official real term indexes at ‘1985 prices’.)However, according to the estimate by the EPAJ, the increase in real fixed
capital stock in manufacturing enterprises was fivefold during the same
period (see back number series of EPAJ, National Economic Accounts
Quarterly,and see also Niwa (1995, p.89)).

The discrepancy between thetwo values ( 2.4 times vs. 5 times) is quite large, though we must consider the
possibility of increases in the required capital / output ratio. The EPAJ has
ignored this inconsistency.

6)

See EPAJ (1994, op. cit., pp. 145-146 and annotation 1-16, pp. 451-452).

- 16 -

17

7)

Cf. L. R. Klein (1968, p. 101).

8)

See also EPAJ (1994, op. cit., annotation 1-16, pp. 451-452).

9)

See Denison (1974), Bergson (1963, pp. 1-37), and Moorsteen & and Powell(1966, pp. 245-273).

10)

Niwa (2001, pp. 42-50).

11) See Niwa (2001, op. cit., pp. 47-50).

12)

The Economic Research Institute of EPAJ emphasized that the series of statisticsof the enterprises’ fixed capital stock compiled by EPAJ would be a very good reliableindicator for the productive capability of capital plant. See Economic research Institute of
EPAJ (1993), National Economic Accounts Quarterly, No. 96, March, pp. 170-172.

13)

The relative shares of earnings of both production factors can be derived from theofficial GDP accounts as follows (at current prices).
Year

Labor

Capital

1975

0.550

0.450

1980

0.542

0.458

1985

0.544

0.456

1990

0.548

0.452

1995

0.569

0.431

See EPAJ (1989, p. 80 and p.139), EPAJ (1995, PP.80-81 and 138-141). See also
EPAJ (1997, pp. 67 and 112-113).

14)

Cf. Solow (1957, pp. 312-320).

15)

See EPAJ (1967, pp.68-69). See also Kashiwagi and Sekiguchi (1999, pp. 62-75).

- 17 -

18

16)

See Kashiwagi and Sekiguchi (1999, pp. 62-75). However, it should be noted thatin this work by Kashiwagi and Sekiguchi did not calculate the rate of technologicalprogress as a pure ex-ante concept (excluding the idle-capacity effect) .

17)

In the computing procedure for the ‘full capacity GDP (or GNP) index’, we must

check whether the initial value (i.e., value for 1970) of the index is appropriate for theassumed economic situation of ‘full employment & full utilization’. Of course, in 1970
Japan surely enjoyedhigh-speed economic growth. Even so, in 1970, according to theWhite Paper, 1972, (Japanese edition), EPAJ(1972), p. 282, the deflationary gap for the
manufacturing industry of Japan (not using the inappropriate concept) was cited as 9.47%.
In other words, the operating-ratio of manufacturing industry in 1970 was 0.9053.
The White Paper, 1972 did not show any yearly value of the deflationary gap or
operating ratio in 1970 for all sectors of the national economy, as a whole. However, theEPAJ(1973), White Paper, 1973, p. 301 provided a set of quarterly data series of thedeflationary gap (the orthodox concept) for both the manufacturing industry and all
economic sectors as a whole in the period, 1962-72. Using the data series, we canestimate a regression equation as cited below:Y= 0.5001(14.851)+ 0.49165・X(13.443)

R = 0.8983,

DW = 1.2943 ,where Y is the operating ratio in all economic sectors as a whole, while X is the operating
ratio in manufacturing industry. Substituting 0.9053, the yearly value for 1970, for X in
this equation, we can compute the yearly value of Y for 1970 as 0.9452. In other words,
the yearly value of the deflationary gap for all economic sectors as a whole in 1970 is
estimated as 5.48% . It would be not quite up to the situation of ‘full employment & full
utilization’.
In this study, as stated in the text, I assumed that a deflationary gap as low as 3%, i.e.,
0.97 as the operating ratio, would be virtually equivalent to the situation of ‘full
employment & full utilization’. Therefore, the author has fixed 102.62 ( = 100×1.0262 )as the initial value (for 1970) of the index number (actual value in 1970 = 100) of ‘full
capacity GDP (or GNP)’, because 0.97 ÷ 0.9452 = 1.0262 .

- 18 -

19

18)

In the official national income accounts for 1985, the income (other than

imputed rent) of not-incorporated private enterprises is 22.73 trillion yen. The
ratio of employees’ compensations excluding public sectors to GNP (exclusive of
public sectors and private not-incorporated enterprises) is 0.549. Therefore, it isplausible to impute 12.48 ( =22.73×0.549 ) trillion yen to the earnings of labor.
Adding the 12.48 to 173.89, which is the original official value of the employees’
compensations in the national income accounts for 1985, we get 186.38 trillion yen.
Hence, the official value of GNP for 1985 is 321.56 (while GDP is 320.42) trillion
yen, the adjusted weight for labor is 0.58 (=186.38÷321.56 ) and for capital is 0.42.
As for the source for the derivation of ‘adjusted weights’ stated here, see EPAJ (1991, pp. 81,
141, 180-181).

19)

The series of real GDP at factor cost is derived from the official ’68 SNA’ GDPaccount as follows.
(Calendar year; trillion yen)
1970

1985

1990

1993

① GDP at 1985 market prices

171.7

320.4

399.0

419.8

② Indirect taxes at 1985 market prices*

10.3

21.3

28.7

30.4

③ GDP at 1985 factor cost (①‑②)

161.4

299.1

370.3

389.4

1995

2000

④ GDP at 1990 market prices

452.3

461.9

487.0

⑤ Indirect taxes at 1990 market prices*

32.1

34.1

39.6

⑥ GDP at 1990 factor cost (④‑⑤)

420.2

427.8

446.4

241.3

245.7

256.3

**

⑦ Linked index (1970 = 100)

100.0

185.3

229.4

* …‥ Net of subsidies. Values at current prices have been deflated by ‘GDP deflator’.
* * …‥ The series of ③ has been liked with the series of ⑥ at 1993.

Sources: EPAJ and Cabinet Office of Government, Annual Report on National Accounts,
1995, 2000 and 2002, and the official announcement of ’68 SNA’ estimate for 2000
on the internet home page of Cabinet Office, posted on June 21, 2001.

20)

Needless to say, for imputation reckoning to estimate the factor cost account of- 19 -

20

GDP by end use, as a matter of fact, almost all the values of indirect taxes net of subsidies
must be subtracted from ‘private final consumption expenditures’ at market prices. It
means, in the total values of government expenditures there would be little changes
through such imputation reckoning. Its implied corollary is that the subtracted values ofindirect taxes net of subsidies should be treated as an imputed fictitious addition to direct
taxes, e.g. income tax. After due consideration about it, the author has tried to derive theaggregation weight for labor inputs as the ratio of ‘actual value of the compensations for
employee / value of GDP at factor cost’ in 1985. The value of employees’ compensationin i985 is 173.1 trillion yen (see EPAJ, Annual Report on National Accounts, 1995, p.140),
and the 1985 value of GDP at factor cost is 299.1 trillion yen (as cited in Footnote 19
above).Therefore, the weight for labor inputs is 0.58 (= 173.8÷ 299.1).Then, the weightfor capital inputs is 0.42.

21) The adjusted value of employees’ compensations inclusive of a part of the incomeof not-incorporated private enterprises in 1985 is estimated as 186.3 trillion yen as citedin Footnote 18 above. So, for the factor cost account, the adjusted weight for labor inputs
is calculated as 0.62 (= 186.3 ÷ 299.1). The weight for capital is 0.38.

22)

Sato (2001, pp. 24-25).

23)

Okun (1973, pp. 211-213).

24)

The

trend

of

labor

productivity

can

be

derivedasfollows.

1990

1995

①The number of employed persons (1980=100)

112.90116.64②Average weekly hours worked (1980=1.0)*

0.98070.9313③Total hours worked (①×②) (1980=100)

110.72108.63④ Real GDP (1980=100)

149.61160.73⑤ Labor productivity (④÷③) (1980=1.0)

1.3512

1.4796⑥Annual growth rate of labor productivity (%)

3.06

2.65

- 20 -

21* …‥ per head of employed persons
Sources: For ① and ②, see Bureau of Statistics, Monthly Statistics ofJapan, back number series. For ④ see footnote to Table 2.

25)

Derivation of the ratios is as follows.
1990

1995

①The actual number of employed persons (1970=100)

122.7

126.8

②Average weekly hours worked (1970=1.0)*

0.94810.9004③Total actual hours worked (①×②) (1970=100)

116.3

114.2

④Total full employment worked hours (1970=100)

123.9

129.4

⑤Full employment/actual employment (④÷③)

1.06531.1331* …‥ per head of employed persons
Sources: For ① and ②, see Bureau of Statistics, Monthly Statistics of Japan, backnumber series. For ④, see Appendix Table 1.

26)

See Harada and Iwata (2002, pp.23-25), chapter 2, written by Noguchi. However,the usage of the word ‘natural rate of unemployment’ by Noguchi has somewhat definite
meaning different from neo-classical Lucasian concept.

27)

Niwa (2000, p.255).

28) See EPAJ (1995, pp. 118-121).

29)

See Cabinet Office (2001, pp. 119-120 and 226-228).

30)

See Cabinet Office (2001, op. cit., p. 227).

31) See Cabinet Office (2001, op. cit., pp.226-227).

32)

See Cabinet Office (2001, op. cit., pp. 33-34).

- 21 -

22

References:
Bergson, A., 〔1963〕,

National Income , in Bergson, A. and Kuznets, S. (ed.), Economic

Trends in the Soviet Union, Cambridge, MA.: Harvard University Press, pp.1-35.
Bureau of Statistics (or Statistics Bureau), Government of Japan, back number series, Monthly
Statistics of Japan.
Cabinet Office, Government of Japan, internet home page, http://www.cao.go.jp/
Cabinet Office,〔2001〕, Annual Report on Japan’s Economy and Public Finance (Fiscal 2001),
Tokyo: Printing Bureau of Ministry of Finance.
Cabinet Office, Economic and Social Research Institute,〔2001 and 2002〕, series of Annual
Report on National Accounts, Tokyo: Printing Bureau of Ministry of Finance.
Denison, E. F.〔1974〕, Accounting for United States Economic Growth, 1929-1969, Washington,
D.C : The Brookings Institution.
Dornbusch, R. and Fischer, S. 〔1978〕, Macroeconomics, New York.: McGrow-Hill, Inc..
Economic Research Institute, EPAJ, back number series, National Economic Accounts
Quarterly.
EPAJ (Economic Planning Agency of Japanese Government ), 〔1967, 1972, 1973, 1994 1998,
1999 and 2000〕, series of Economic White Paper, (Japanese edition), Tokyo: Printing Bureauof Ministry of Finance.
EPAJ, 〔1989, 1991, 1995, 1997 and 2000〕, series of Annual Report on National Accounts,
Tokyo: Printing Bureau of Ministry of Finance.
EPAJ, back number series, Handbook of Economic Statistic, Tokyo: Printing Bureau of Ministryof Finance.
EPAJ, back number series, Japanese Economic Indicators Quarterly.
Fair, R. C.〔1989〕,”Book Review on Lucas’s Models of Business cycles”, Journal of Economic
Literature,Vol.27, March, pp.104-105.
Harada, Y. and Iwata, k.. (ed.) 〔2002〕, Deflation: Positive Analyses, (in Japanese), Tokyo:
Toyo Keizai Shinpo Sha.
Kashiwagi, T. and Sekiguchi, S.〔1999〕,

Extensive Growth and Intensive Growth: A

comparison of Japan and China , (in Japanese), JCER Economic Journal, No. 38, March ,pp.62-92.

- 22 -

23

Klein, L.R.〔1968〕, An Introduction to Econometrics, Englewood Cliffs NJ: Prentice-Hall, Inc..
Klein, L. R. and Kumasaka, Y.〔1995〕,
Era

The Re-opening of the U.S. Productivity-led Growth, NLI Research, Vol.76, February, pp.3-19.

Lucas, R.〔1987〕, Models of Business Cycles, Oxford: Blackwell.
Moorsteen, R. & Powell, R. P. 〔1966〕, The Soviet Capital Stock, 1928-1962, Homewood,
Illinois: Richard D. Irwin, Inc.
Nihon Keizai Shinbun Sha, NEEDS(database).
Niwa, H. 〔1995〕, A quantitative measurement of the size of deflationary gap in recent Japan ,( in Japanese), The Osaka Gakuin Review of Economics, Vol.9(1), April, pp.65-102.
Niwa, H. & Special Committee on Globalization Problems of Science Council of Japan (SCJ),(ed.) 〔1996〕, Overcoming the Industrial Holing-out Problems in Japan, (in Japanese),Tokyo: Secretariat of SCJ.
Niwa, H. 〔1999〕, Economics of Revival for Japanese Economy, (in Japanese), Tokyo: Hara
Syobo.
Niwa, H.〔2000〕, “The recent deflationary gap in Japan: a quantitative measurement”, Journalof Asian Economics, Vol.11: pp.245-258.
Niwa, H.〔2001〕, ”A Detailed Analysis on Some Special Characteristics of Lucas’s ASL / LAS
under Generalized Conditions: A Synthetic Understanding of Both Lucasian and Keynesian
Systems”, (in Japanese), Planning Administration, Vol. 24(3), Sept., pp.42-50.
Okun, A. M. 〔1973〕, “Upward Mobility in a High-pressure Economy”, Brookings Papers on
Economic Activity, 2, pp.207-261.
Sato, K. 〔2001〕, “Japan’s GDP Estimates: A Critical Review”, Journal of Asian Economics,
Vol. 12, pp.21-36.
Solow, R. M.〔1957〕,

Technical change and aggregate production function , The Review of

Economics and Statistics, Vol.39, August, pp.312-320.
Toyo Keizai Shinpo Sha,〔1992〕, Year Book of Economic Statistics, 1992, (Toyo Keizai Data
Bank), Tokyo: Toyo Keizai Shinpo Sha.
Toyo Keizai Shinpo Sha,〔1998〕, Toyo Keizai Statistics Monthly, July.
Yoshikawa, H.〔1998〕, “Macroeconomic Policy in Japan”, ( in Japanese), The Annual of Japan
Economic Policy Association, No.46, pp. 7-17.

- 23 -

24

Table 1 Implausible Rate of Technological Progress Derived from
EPAJ’s White Paper Data

1970 → 93

1980 → 93(1) Aggregate Input (fixed capital stock & labor)

2.363 times( 3.81 % per annum)

1.541 times( 3.38 % per annum)(2) Real GDP (at 1985 prices )2.445 times( 3.96 % per annum)

1.574 times( 3.55 % per annum)(3) Technological Progress (2) – (1)(Solow’s residual)( 0.15 % per annum)( 0.17 % per annum)(4) Capital / Output Ratio

2.310 times( 3.71 % per annum)

1.491 times( 3.12 % per annum)

(

Note:

For the computation of aggregate inputs index ( Line 1 ), theaggregation weight is 0.456 for real input index of enterprises’ fixed capital stock( at 1985 prices )and 0.544 for labor input index (in terms of total hours worked ).

The weights are derived from the official national income (GDP) account for 1985 as
the relative proportions of earnings for capital and labor. See EPAJ(1991, pp.80-81).
The aggregate computation has been worked out by the use of a weighted geometricmean formula. For the detailed procedures of calculation and data sources for thetable, see Haruki Niwa (1995, p.74).

For official GDP index, see footnote toAppendix Table 2 〔1〕below.
In case we tried to adjust the imputation of the incomes of small
not-incorporated private enterprises, the computed weight is 0.42 for capital and 0.58
for labor, as discussed in Section 6 in the text. When we use the adjusted weights, thecomputed increase in aggregate input is 2.245 times during the 1970-93 period or3.579% growth per annum. The rate of technological progress (the Sollow’s residual)is 0.38% per annum. The increase in capital/output ratio is 2.31 times during the same
period.

- 24 -

25

Table 2 (A)Computation of Deflationary Gap in Japan, 1995 and 2000
(Based on real GDP accounts at 1985 market prices)

full
required
capacity capital/output
real GDP+ ratioδ↓ ---(actual 1970 = 100)---(actual real GDP)÷(full capacity realGDP)++

DeflationaryGap(%)

Computed 1995 level of
1/3(a) 455.1(b) 417.4

146.1
159.2

(a) 0.549(b) 0.598(a) 45.1(b) 40.2

1/3.5(a) 413.3(b) 381.1

160.8
174.4

(a) 0.604(b) 0.655(a) 39.6(b) 34.5

1/4(a) 387.5(b) 358.6

171.5
185.4

(a) 0.644(b) 0.696(a) 35.6(b) 30.4

1/5(a) 357.4(b) 332.3

186.0
200.0

(a) 0.699(b) 0.751(a) 30.1(b) 24.9

Computed 2000 level of
1/3(a) 528.0(b) 479.5

153.8
169.4

(a)
(b)

0.498
0.548

(a) 50.2(b) 45.2

1/3.5(a) 474.9(b) 433.8

171.0
187.3

(a) 0.553(b) 0.606(a) 44.7(b) 39.4

1/4(a) 442.3(b) 405.7

183.7
200.2

(a) 0.594(b) 0.648(a) 40.6(b) 35.2

1/5(a) 404.7(b) 373.1

200.7
217.7

(a) 0.649(b) 0.704(a) 35.1(b) 29.6(a) By the use of ‘original weights’.

(b) By the use of ‘adjusted weights’.

+With allowance for the minimum deflationary-gap (i.e., 3%). See footnote 17 in the text.

++

The value of index number for actual 1995 GDP is 249.7 and for actual 2000 GDP is262.8 (1970 = 100). See note to Appendix Table 2〔1〕.

- 25 -

26

Table 2 (B) Computation of Deflationary Gap in Japan, 1995 and 2000
(Based on real GDP accounts at 1985 factor cost)
full
required
capacity capital/output
real GDP+ ratioδ↓ ---(actual 1970 = 100)---(actual real GDP)÷(full capacity realGDP)++

DeflationaryGap(%)

Computed 1995 level of
1/3(a) 417.4(b) 379.1

159.2
175.3

(a) 0.589(b) 0.648(a) 41.1(b) 35.2

1/3.5(a) 381.1(b) 348.2

174.4
190.9

(a) 0.645(b) 0.706(a) 35.5(b) 29.4

1/4(a) 358.6(b) 329.0

185.3
202.0

(a) 0.685(b) 0.747(a) 31.5(b) 25.3

1/5(a) 332.3(b) 306.4

200.0
216.9

(a) 0.739(b) 0.802(a) 26.1(b) 19.8

Computed 2000 level of
1/3(a) 479.5(b) 430.7

169.5
188.7

(a) 0.535(b) 0.595(a) 46.5(b) 40.5

1/3.5(a) 433.8(b) 392.3

187.3
207.1

(a) 0.591(b) 0.653(a) 40.9(b) 34.7

1/4(a) 405.7(b) 368.6

200.2
220.4

(a) 0.632(b) 0.695(a) 36.8(b) 30.5

1/5(a) 373.1(b) 340.9

217.8
238.3

(a) 0.687(b) 0.752(a) 31.3(b) 24.8(b) By the use of ‘original weights’.

(b) By the use of ‘adjusted weights’.

+With allowance for the minimum deflationary-gap (i.e., 3%). See footnote 17 in the text.

++

The value of index number for actual factor cost GDP in 1995 is 245.7 and for actual
factor cost GDP in 2000 is 256.3 (1970 = 100). See footnote 19 in the text.

- 26 -

27

Appendix Table 1

Aggregate ‘Full-Employment & Full-Utilization Index’of Labor Force and Enterprises’ Fixed Capital Stock, 1970-2000
(1)

(2)

Full-employment
level of labor#
force

Real fixed capitalstock of enterprises
in all sectors＃＃(at the beginningof each year)(Actual employment level in1985 = 100)

(1985 = 100)

Year
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
#

90.49
91.06
91.29
93.50
93.23
93.46
94.44
95.73
97.13
98.26
99.20
100.21101.38103.39104.07104.70105.69106.82108.27110.09112.10114.22115.50116.14116.68117.05117.83119.18119.28119.04118.79

29.71
34.56
39.17
43.96
48.86
53.47
57.86
61.78
65.71
69.50
74.17
79.21
84.42
89.43
94.37
100.00111.57118.78127.71135.34145.29156.88171.40182.16190.18197.44205.06214.43225.05233.95241.34Aggregate ‘full-employment &full-utilization index’(3)
Weighted geometricmean of (1) and (2)(based on market
prices account)＃＃＃(a)(b)
Original Adjusted
54.45
56.68
58.54
60.62
62.07
63.99
66.28
68.10
69.44
71.07
72.45
73.92
75.53
76.87
78.40
79.65
81.28
82.43
83.90
84.96
86.89
87.80
90.02
90.78
93.26
93.87
96.77
97.28
99.53
99.88
102.53102.70108.33108.12112.11111.69116.74116.05120.96120.06126.17125.00132.00130.50138.27136.32142.60140.31145.79143.25148.56145.79151.70148.70155.78152.52
159.33155.73161.99158.10164.12
159.98(4)The same seriesas (3)(based on factor costaccount)＃＃＃＃(c)(d)
Original Adjusted
56.68
59.26
60.62
63.01
63.99
66.19
68.10
70.19
71.07
72.93
73.92
75.59
76.87
78.40
79.65
81.05
82.43
83.73
84.96
86.14
87.80
88.83
90.78
91.64
93.87
94.56
97.28
97.84
99.88 100.27
102.70 102.89
108.12 107.89
111.21111.69115.28116.05120.06 119.08
125.00 123.71
130.50 128.86
136.32 134.19
140.31 137.80
143.25 140.48
145.79 142.78
148.70 145.44
152.52 148.98
155.73 151.82
158.10 153.88
159.98 155.51

As cited in the text, in the present study, it is operationally assumed that the rate of employedlabor force and average hours worked per head of employed persons in 1970 are virtually equivalent
to the conceptual conditions of ‘full employment’. Therefore, it can be assumed that the index
number of full-employment level could be regarded as identical with the index number of actual totallabor force (1985 = 100) multiplied by 1.047 ( in consequence, the value of the index number for- 27 -

28

1985 is 104.7 as cited in the table). Of course, the index of total labor force can be easily derived
from the official statistics published by the Statistics Bureau of the Government of Japan. Here, thecoefficient, 1.047, shows the difference of ‘rate of employed’ (adjusted for changes in hours worked)
in 1970 compared with the corresponding rate in 1985. The derivation of the coefficient is as follows.
That is, the comparative ‘rates of employed’ in 1970 and 1985 unadjusted for hours worked areshown below.
Total labor force

Employed

Rate of employed― (Millions of persons) ―1970

51.53650.9390.9884

1985

59.63458.0700.9738The average weekly worked hours per head of employed persons were 48.2 in 1970 and 46.7
in 1985. Consequently, the coefficient should be computed as( 0.9884 ÷ 0.9738 ) × (48.2 ÷ 46.7) = 1.047 .
The computations relied on the database, NEEDS, provided by Nihon Keizai Shinbun Sha. See
also Bureau of Statistics, Office of the Prime Minister (1974, Oct. pp. 7-10, & 1989, Jan.pp.15 -19).

＃＃

This is a linked index. The series of enterprises’ fixed capital stock in real terms at 1985

prices (inclusive of construction work in progress) compiled by the Economic Research Institute of
EPAJ for 1970-93 has been linked with the similar series for 1993-2000 in real terns at 1990 prices.
See the back number series of EPAJ, Japanese Economic Indicators Quarterly and Economic
Research Institute, EPAJ, National Economic Accounts Quarterly.

＃＃＃

(a)

‘Original weight’ for labor (column (1) ) is 0.544 and weight for capital (column (2) )is 0.456. The weights are derived from the official GDP account for 1985 (68 SNA) as the relative
proportions of earnings for labor and capital.
(b)

＃＃＃＃

See EPAJ (1991, pp. 80 – 81).

‘Adjusted weight’ for labor is 0.58 and for capital is 0.42. See Section 6 in the text.

(c)‘Original weight’ for labor ( column (1) ) is o.58 and weight for capital ( column (2) )is 0.42. See footnote 20 in the text. The computed results of (c) is same to (b) due to same weights.
(d) ‘Adjusted weight’ for labor is 0.62 and for capital is 0.38. See footnote 21 in the text.

- 28 -

29

Appendix Table 2〔1〕 Results of Simulation( Actual 1970 = 100 )δ =1 / 3

1970

1980

1985 1990

1993

1995

1997

2000

(1) Actual real GDP

mp
fc

100
100

155.4 186.7 232.5 244.5 249.7* 266.5* 262.8*
155.6 185.4 229.5 241.3 245.7# 262.2# 256.3#(2) Full capacity real GDP

(a)mp
(b)mp
(a)fc
(b)fc

102.6
102.6
102.6
102.6

205.1
196.4
196.4
187.1

(1) ÷ (2)

(a)mp
(b)mp
(a)fc
(b)fc

0.974§
0.974§
0.974§
0.974§

262.4
248.0
248.0
232.9

357.0
332.0
332.0
306.2

428.1
394.2
394.2
359.5

455.1 488.5
417.4 446.4
417.4 446.4
379.1 403.9

528.0
479.5
479.5
430.7

0.758
0.791
0.792
0.832

0.712
0.753
0.748
0.796

0.651
0.700
0.691
0.749

0.571
0.620
0.612
0.671

0.549 0.546
0.598 0.597
0.589 0.587
0.648 0.649

0.498
0.548
0.535
0.595

(4) Required capital/output ratio for (2)(a)mp 97.4(b)mp 97.4
(a)fc
97.4
(b)fc
97.4

121.7
127.2
127.2
133.5

128.3
135.8
135.8
144.6

137.0
147.3
147.3
159.7

143.2
155.6
155.6
170.6

146.1 147.7
159.2 161.7
159.2 161.7
175.3 178.7

153.8
169.4
169.5
188.7

mp … Real GDP at market prices.

fc … Real GDP at factor cost.

(3)* … This is a linked index. The official real GDP (68 SNA) index at 1985 prices for
1970-93 has been linked with the similar official index for 1993-2000 at 1990 prices.
See EPAJ, Annual Report on National Accounts, (1995, pp.118-121 and 2000, p. 101).
The value for 2000 (68 SNA) has been posted (June 21, 2001) on the internet home pageof Cabinet Office.
# … This is also a similar linked index of real GDP at factor cost. See footnote 19 in the text.
(a) … By the use of ‘original weights’. See footnotes to Table 1 and Appendix Table 1.
(b) … By the use of ‘adjusted weights’. See Section 6 in the text and also see footnotes toTable 1 and Appendix Table 1.
§… Exclusive of the minimum deflationary gap (i.e., 3%).

As cited in footnote 17 in thetext, 0.97 ÷ 0.9452 = 1.0262 . 100 ÷ 102.62 = 0.97447 ≒ 0.974 .
Lines (b)mp and (a)fc of (2) have a series of same values.

Similarly, Lines (b)mp and (a)fcof (4) also have a series of same values. Reason for it is that the aggregation weights are
happened to be same to both.

- 29 -

30

Appendix Table 2 〔2〕 Results of Simulation (Continued)
δ=1/ 3.5

1970

1980

( Actual 1970 = 100 )1985 1990

1993

1995

1997

2000

(1) Actual real GDP

mp
fc

100
100

155.4 186.7 232.5 244.5 249.7* 266.5* 262.8*
155.6 185.4 229.5 241.3 245.7# 262.2# 256.3#(2) Full capacity real GDP

(a)mp
(b)mp
(a)fc
(d)fc

102.6
102.6
102.6
102.6

196.1
188.3
188.3
180.0

(1) ÷ (2)

(a)mp
(b)mp
(a)fc
(b)fc

0.974§
0.974§
0.974§
0.974§(3)(4) Required capital/output ratio for (2)(a)mp 97.4(b)mp 97.4
(a)fc
97.4
(b)fc
97.4
(a), (b),

mp,

246.9
234.2
234.2
220.8

329.4
307.7
307.7
285.3

390.4
361.3
361.3
331.4

413.3 444.6
381.1 405.9
381.1 405.9
348.2 369.5

474.9
433.8
433.8
392.3

0.792
0.825
0.826
0.865

0.756
0.797
0.792
0.840

0.706
0.756
0.746
0.805

0.626
0.677
0.668
0.728

0.604 0.599
0.655 0.657
0.645 0.646
0.706 0.710

0.553
0.606
0.591
0.653

127.3
132.6
132.6
138.7

136.3
143.7
143.7
152.4

148.5
159.0
159.0
171.5

157.1
169.7
169.7
185.0

160.8
174.4
174.4
190.9

171.0
187.3
187.3
207.1

162.3
177.9
177.9
195.4

fc, *, #, and §…‥ See footnote to Appendix Table 2 [1] above.

Appendix Table 2 〔3〕 Results of Simulation
δ =1 / 4

1970

1980

(C0ntinued)
1985 1990( Actual 1970 = 100 )
1993

1995

1997

2000

(1) Actual real GDP

mp
fc

100
100

155.4 186.7 232.5 244.5 249.7* 266.5* 262.8*
155.6 185.4 229.5 241.3 245.7# 262.2# 256.3#(2) Full capacity real GDP

(a)mp
(b)mp
(a)fc
(d)fc

102.6
102.6
102.6
102.6

190.4
183.1
183.1
175.4

237.1
225.4
225.4
213.1

312.1
292.4
292.4
272.0

367.0
340.8
340.8
313.9

387.5 412.7
358.6 380.8
358.6 380.8
329.0 348.1

442.3
405.7
405.7
368.6

(1) ÷ (2)

(a)mp
(b)mp
(a)fc
(b)fc

0.974§
0.974§
0.974§
0.974§

0.816
0.849
0.850
0.887

0.787
0.828
0.822
0.870

0.745
0.795
0.785
0.844

0.666
0.717
0.708
0.769

0644 0.646
0.696 0.700
0.685 0.689
0.747 0.753

0.594
0.648
0.632
0.695

131.1
136.4
136.4
142.4

142.0
149.3
149.3
158.0

156.7
167.3
167.3
179.8

167.1
179.9
179.9
195.4

171.5
185.3
185.3
202.0

183.7
200.2
200.2
220.4

(3)

(4) Required capital/output ratio for (2)(a)mp 97.4(b)mp 97.4
(a)fc
97.4
(b)fc
97.4

(a), (b),

mp,

fc,

*,

174.9
189.6
189.6
207.3

#, and §…‥ See footnote to Appendix Table 2 [1] above.

- 30 -

31

Appendix Table 2 〔4〕 Results of Simulation
δ =1 / 5

1970

1980

(Continued)
1985 1990( Actual 1970 = 100 )
1993

1995

1997

2000

(1) Actual real GDP

mp
fc

100
100

155.4 186.7 232.5 244.5 249.7* 266.5* 262.8*
155.6 185.4 229.5 241.3 245.7# 262.2# 256.3#(2) Full capacity real GDP

(a)mp
(b)mp
(a)fc
(d)fc

102.6
102.6
102.6
102.6

183.4
176.8
176.8
169.7

225.4
214.9
214.9
203.8

291.7
274.4
274.4
256.3

339.6
316.8
316.8
293.2

(1) ÷ (2)

(a)mp
(b)mp
(a)fc
(b)fc

0.974§
0.974§
0.974§
0.974§

0.849
0.881
0.880
0.917

0.828
0.869
0.863
0.910

0.804
0.855
0.836
0.895

0.720
0.772
0.762
0.823

136.2
141.2
141.2
147.1

149.3
156.7
156.7
165.2

167.7 180.6
1783 193.6
178.3 193.6
190.8 209.2(3)(4) Required capital/output ratio for (2)(a)mp 97.4(b)mp 97.4
(a)fc
97.4
(b)fc
97.4

(a), (b),

mp,

fc,

*,

357.4 379.2
332.3 351.5
332.3 351.5
306.4 323.1
0.699 0703
0.751 0.758
0.739 0.746
0.802 0.811

0.647
0.704
0.687
0.752

186.0
200.0
200.0
216.9

200.7
217.8
217.8
238.3

190.3
205.3
v205.3
223.4#, and §…‥ See footnote to Appendix Table 2 [1] above.

- 31 -

404.7
373.1
373.1
340.9

32

Potential GDP highPotential GDP middle
Potential GDP low
GDP actual

Graph 1. Trend of Deflationary Gap in Japan ( real values at 1985 constant prices )By the use of 'original weights' (1970 actual value = 100 )600

2000 potential value( δ = 1/ 3.5 )= 815 tril. Yen( = 878 tril. yenat 1990 prices )( full employment &full-capac . operation )Real GDP (1970 actual value = 100)500
δ = 1/ 3400
δ= 1/4300

2000 actual value= 451 tril . Yen( = 486 tril. yenat 1990 prices )

200

100

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

1979

1978

1977

1976

1975

1974

1973

1972

1971

1970

0

Graph 2. Trend of Deflationary Gap in Japan ( real values at 1985 constant prices )By the use of 'adjusted weights' ( 1970 actual value = 100 )Potential GDP highPotential GDP middle
Potential GDP low
GDP actual

600

500

2000 potential value(δ = 1/ 3.5 )= 745 tril. yen( = 803 tril. yenat 1990 prices )( full employment &full-capac . operation )400

δ= 1/ 4300

2000 actual value= 451 tril . yen( = 486 tril. yenat 1990 prices )

200

100

- 32 -

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

1979

1978

1977

1976

1975

1974

1973

1972

1971

0
1970

Real GDP (1970 actual value = 100)

δ = 1/ 3

33

Potential GDP highPotential GDP middle
Potential GDP low
GDP actual

Graph 3. Trend of Deflationary Gap in Japan ( real values at 1985 factor cost )By the use of 'original weights' at factor cost account ( 1970 actual value = 100 )600

Real GDP (1970 actual value = 100)

500
2000 potential value( δ = 1/ 3.5 )= 700 tril. Yen( = 755 tril. yenat 1990 factor cost )( full employment &full-capac . operation )δ = 1/ 3400

δ= 1/4300

2000 actual value= 414 tril . Yen( = 446 tril. yenat 1990 fator cost)

200

100

1993
1994
1995
1996
1997
1998
1999
2000

1983
1984
1985
1986
1987
1988
1989
1990
1991
1992

1974
1975
1976
1977
1978
1979
1980
1981
1982

1972
1973

1970
1971

0

Graph 4. Trend of Deflationary Gap in Japan ( real values at 1985 factor cost )By the use of 'adjusted weights' at factor cost account ( 1970 actual value = 100 )Potential GDP highPotential GDP middle
Potential GDP low
GDP actual

500
450

350
δ= 1/ 4300
250

2000 actual value= 414 tril . yen( = 446 tril. yenat 1990 factor cost)

200
150
100
50

- 33 -

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

1979

1978

1977

1976

1975

1974

1973

1972

1971

0
1970

Real GDP (1970 actual value = 100)

2000 potential value(δ = 1/ 3.5 )= 633 tril. yen( = 683 tril. yenat 1990 factor cost)( full employment &full-capac . operation )δ = 1/ 3400