The Impact of the Earthquake on the Output Gap and Prices

Bank of Japan May 2011 The earthquake that struck Japan in March 2011 has reduced the supply capacity of the economy, which works in the direction of tightening the output gap. At the same time, however, if weak household and corporate sentiment lead to a decline in aggregate demand, this will work in the direction of increasing the slack in the economy. Moreover, developments in supply and demand conditions will differ for different goods and services. The impact of the earthquake on the output gap and prices, therefore, is not straightforward. Moreover, for these reasons, caution is needed when interpreting the results of production function estimates of the output gap. However, as long as mediumto long-term inflation expectations remain stable, temporary changes in the output gap due to the earthquake will have little effect on general prices in the economy as a whole.