Is Japan’s consumer price index biased upward? Evidence from Engel curve estimation

The Japanese economy has been experiencing low or negative growth and deflation since the time the Japanese asset price bubble collapsed in early 1990s. Japan has also been suffering from insufficient employment opportunities including the issue of non-regular employment. This paper is the first study that constructs alternative estimates of Japan’s growth and price level using Engel curves including the time periods referred to as "Japan’s lost decades." An Engel curve demonstrates the empirical relationship between household expenditure on a good or service and household income – richer households spend a smaller portion of expenditure on necessities, but spend a larger portion on luxuries. The baseline theoretical model to estimate consumption growth and price level used in this paper was developed by Nakamura et al (2016). The method was originally established in earlier works such as Nakamura (1996), Hamilton (2001) and Costa (2001). When the Engel curve in a year shifts downward (upward) compared with the curve in the previous year, it can be inferred that a smaller (larger) portion of expenditures was spent on a particular good or service in the year. It can be assumed that such a downward (upward) shift of Engel curves implies the official statistics such as the government announcement of growth is biased downward (upward) and CPI is biased upward (downward). This paper uses expenditure and CPI data for disaggregated product categories provided by the Statistics Bureau, Ministry of Internal Affairs and Communications. Our investigation starts after 2002 since the continuous detailed quarterly data for expenditure are only available since 2002. We use panel data based on the prefectures and income groups. The results of this paper show the direction and magnitude of Japan’s CPI and growth biases. By definition, Engel curve-based growth and inflation are affected by the official inflation, food prices, and income. Japan’s Engel coefficients have been showing a slowly increasing tendency after 2005, and this tendency turned out to be drastic after 2014, which is consistent with the rise in the official overall CPI and food CPI. The declining tendency in income and the drastic rise in food prices in Japan in the past few years especially after 2014 causes upward shifts of Engel curves. The results measured by Engel curve estimation show that Japan’s official inflation is biased upward and official growth is biased downward until 2014, and the direction of the bias switches in 2015.