In our prior article on the government's willingess and ability to create inflation, we noted that Japan is often held up as an example of a country that was unable to inflate despite having a fully paper-based monetary system. But while the crash of Japan's credit-fueled stock and real estate bubbles resembles our own situation, the monetary policy responses in each case have been markedly different.

It's true that the Japanese authorities did not create any enduring price inflation after their credit crash. But a quick look at the data shows that this is because they opted not to do the one thing that can reliably create eventual inflation: rapidly grow the supply of money in circulation.
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It is widely understood and agreed upon that substantially increasing the amount of money in the economy will eventually lead to inflation. Yet the Japanese authorities did not take this course. Did they not think to even try it? Did it just never come up at any Bank of Japan meeting for an entire decade?

We think a more plausible explanation stems from the fact that Japan was a nation of savers. Forcing up inflation via broad currency debasement would have harmed Japanese voters by undermining the purchasing power of their savings. As a result, accepting the mild (if lengthy) deflation was likely a more politically viable option than flooding the economy with money.

While bad for savers, inflation is good for debtors because it reduces the purchasing power-adjusted burden of debt. Here in the United States, the authorites face exactly the opposite constraints as those faced in Japan in the 1990s. Our nation is highly indebted and has a low savings rate. In this situation, deflation is a lot more painful than inflation. Politics demanded that Japan avoid inflation - and politics now demand that the United States embrace it.

Whatever the reason, it's very clear that the policy response being pursued by the US is vastly different from what took place after Japan's credit bust. Those predicting a repeat of the Japanese experience should take note.