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Tokyo's Ginza shopping district. Calculations by High Frequency Economics show quarterly employment in Japan has declined 5 per cent since 1998.Toru Hanai/Reuters

In his first testimony before the Diet last week, Bank of Japan Governor Haruhiko Kuroda noted, "Japan's economy has suffered from deflation for nearly 15 years. This is an extraordinary situation even on a global scale."

We would supplement Kuroda-san's statement with the observation that the working-age population and employment have also been declining for 15 years. This is no coincidence.

Economic theory tells us that deflation is a natural consequence of a declining labour supply, as long as technological innovation persists at a faster pace than employment is shrinking. We therefore predict that no amount of monetary stimulus can reverse the trend decline in prices: The roots of Japan's deflation are not monetary.

Calculations by High Frequency Economics show quarterly employment in Japan has declined 5 per cent since 1998. As Japan's huge demographic cohort of baby boomers ages, they are leaving the work force. However, technological innovation has progressed over the past 15 years, independent of declines in the working-age population: GDP per worker – productivity – has risen 14.4 per cent since 1998.

When the population is growing, productivity gains support increases in both aggregate real income – GDP – and real income per capita. This has been the postwar experience of most economies. When the population declines – or retires – demand for goods and services decreases, but gains in per capita income can be realized with a declining level of aggregate production: In this case, increases in productivity support declines in unit labour costs rather than increases in production. This leads to falling prices.

Aggregate demand is falling in Japan, and companies are competing to retain their share. Competition compels them to pass through labour cost savings into lower prices for their products. This is the root of Japan's deflation. We decompose Japan's productivity gains since 1998 into an 8-per-cent increase in GDP over the period, and a 6-per-cent decline in unit labour costs. CPI has, indeed, declined by 6 per cent over this period. Japan's loss of export sales to other producers in Asia exacerbates the drop in demand faced by domestic producers.

Monetary stimulus cannot reverse the downward pressure on prices from innovation and a shrinking work force. Deflation is the constant companion of a declining population in a modernizing world.

Carl Weinberg is the founder and chief economist of High Frequency Economics, an independent economic research firm based in Valhalla, N.Y.