Failed Inflationary Expectations Hurts Japan’s Economy and Politics

… Yates Wilburn …

The Bank of Japan’s efforts to encourage price increases across the Japanese economy have failed to produce the desired results. The ‘goal’ of a 1% increase in the CPI in Japan is now appearing to be a far more long-term expectation than originally desired by the Japanese government as the try to shake the economy out of nearly ’20 years of deflationary pressure.’ As the BOJ considers the purchase of 10 trillion yen in additional assets as a form of easing, officials at the Bank have blamed the downgraded inflation expectations on the appearance of fresh negative issues such as slowing production levels in China as its economy finally begins to feel the full impact of the global recession. This all plays out in the context of a stronger yen acting as a ‘brake’ on exports, a crucial segment of the Japanese economy (WSJ link below).

The problem of deflation in the Japanese economy is hardly a new one, as shown by the BOJ’s own statistics (link below). Since 2006, the CPI (Laspeyres chain index less fresh food) in Japan has only reached positive numbers five times, and then only for a brief six to seven month spurt only for gains to be almost wiped out by dips of equal weight in the opposite direction. The most extreme instance took place in 2008 when the CPI increased by 1% to 2% over the year to be followed by a 2.5% drop the very next fiscal year. The impact of a stronger yen on Japan’s already depressed exports to China (see ‘More Bad News for Japan’s Auto Industry’ blog entry) could be very negative.

In addition to all of this, the poor numbers have revealed a ‘rare display’ of intense division between the BOJ and the Japanese government as officials criticize the Bank for not being clear enough on its inflationary goals. The government itself is also in a state of disharmony, as Prime Minister Noda’s administration may be ‘left without cash as soon as next month’ as a legislative stalemate in the Diet holds up progress on an economic stimulus package (see Bloomberg link below).


2 thoughts on “Failed Inflationary Expectations Hurts Japan’s Economy and Politics

  1. the prof

    How might more aggressive monetary policy lead to inflation? Can you spell out 2-3 chains of causation, from MP to … to higher prices?

  2. myers

    As the article states, deflation is not a new phenomenon in the Japanese economy. The GDP deflator fell 9% between 2000 and 2010. In an interesting piece written by Paul Krugman, he explains the reasons behind Japan’s deflationary pressure back in 2000 when the government was also trying to intentionally cause inflation.

    “A change in a nominal variable, like the money supply, can affect the real economy only if some other nominal variable, like wages, is “sticky” enough to give it some traction… Almost everyone agrees that what is happening in Japan right now is that the savings Japanese residents would want to undertake at full employment exceeds the investment (including net foreign investment) that businesses find profitable. This means, more or less by definition, that the price of current goods in terms of future goods is above its equilibrium level”

    More aggressive monetary policy besides setting a target inflation rate could be to print more money (increase the money supply) so that the purchasing power decreases. The government could also set a more aggressive inflation target, but then there is the risk of hyperinflation.

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