Pass-Through of Oil Prices to Japanese Domestic Prices

In this paper, we investigate changes in the impacts of world crude oil prices on domestic prices in Japan. First, we employ a time-varying parameter VAR (TVP-VAR) approach to confirm that the rate of pass-through of oil prices declined, both at the aggregate and sectoral levels, for the period 1980-2000. Second, by utilizing Input-Output Tables, we find that changing cost structure of Japanese firms goes a long way toward explaining this decline. That is, by the year 2000, oil had become a much smaller component of the Japanese production cost structure. We further find that much of this is attributable to changes in relative prices: as oil became cheaper, it became less important in the overall cost structure, and thus pricing behaviors of firms became less responsive to its prices. Substitution effects, namely firms' shifts toward less oil intensive production, on the other hand, appear to be less important. We also study the period 2000-2007. We find that, although pass-through rates of oil prices increase in many instances, those increases are small in comparison to the drastic resurgence of oil in the cost structure of firms. We present some possible explanations for this finding.