Japan’s Chronic Deflation

Japan’s Chronic Deflation

Japan’s Chronic Deflation : There is a general consensus among economists that deflation is highly unfavorable. Unsurprisingly, Japan’s struggle with deflation has become a global phenomenon.

In the late 1990s, Japan suffered a lengthy recession that led to their inflation rate turning negative for the first time. The following two decades saw the Japanese inflation rate remain largely in the minus column, typically fluctuating between 0 and -1 %.

In other words, the general price level of goods and services in the Japanese economy has been falling each year.

As such, Japanese households are choosing to save their money rather than spend it, as they can reasonably expect to have greater purchasing power the following day, month, and year.

The resultant decreased demand has led to decreased production, ensuing in a vicious deflationary cycle. The questions worth asking now are what effects has deflation had on the Japanese economy and how should Japan navigate itself out of its deflationary spiral?

Figure 1: Inflation, consumer prices for Japan (FRED)

Thailand Embraces Artificial Intelligence

A Rising Vietnam: The Fourth Act

Japan’s central bank has set an inflation target of 2%, but the graph in Figure 1 shows us that, for the past 28 years, it has, for the most part, failed to hit it. Such failure stems from reasons far more complex than insufficient aggregate demand; rather, the unfavorable demographics in Japan play a big role in its deflation.

Not only has the birth rate in Japan fallen every year, but Japanese citizens are also experiencing increased longevity. Both the aging and rapidly declining population has led to a reduced workforce – represented by an inwards shift of Japan’s production possibility frontier (PPF), and consequently, an inwards shift of Japan’s long run aggregate supply (LRAS) too. These concepts are demonstrated on the graphs in Figure 2.

Figure 2: Japan’s PPF (left) and LRAS Curves (right)

An outcome we can observe from the above graphs is the reduction in Japan’s potential output (represented by the fall in PPF and Y*). This is reflected in Japan’s nominal GDP, which is hardly any higher today than it was in 1992. In contrast, the US economy has nearly tripled in size in that time.

Furthermore, Masaaki Shirakawa, a former governor for the Japanese central bank, has suggested that as households and firms begin to realize Japan’s poor demographics will eventually lead to lower economic growth and reduced incomes, they should cut down on both their consumption and investment out of caution, creating further deflationary pressures on the economy (Liu and Westelius, 2016).

These deflationary pressures have led to falling wages in Japan. As a result, Japanese workers are often working 80-hour weeks (including 40 hours overtime) to compensate for lost wages (Wall Street Journal, 2015).

Japan Is Developing The Future of Transportation

Indonesia’s Bright Ai Future

The increasing number of deaths due to overworking has even led to the coining of the word “Karoshi”, which literally translates to “overwork death” (The Economist, 2018).

On the same note, suicide rates in Japan have been on the rise, largely due to the increasing inability for debtors to pay back their loans under deflationary circumstances like lowered growth, high unemployment, and low wages (Yoshitomo, 2017).

Can Japan’s Shinkansen Bullet Train Gain Market Share from Airline Companies?

Automation: The Solution to Japan’s Farming Woes?

Furthermore, the Fisher equation states that r = i – π.

Deflation is represented with a negative π; as such, even if nominal interest rate i is set to zero, the real interest rate r will always be positive. The higher the level of deflation, the higher the real interest rate will be.

Clearly, deflation puts an upwards pressure on real interest rates, which results in further saving by households and reduced investment by firms – evidently, this cycle is a vicious, self-perpetuating one.

In order to tackle its chronic deflation, the Japanese central bank could, in the short run, adopt a quantitative easing policy, whereby it buys government bonds in the open market to increase the money supply.

This would lower the price of money, in turn lowering the purchasing power parity of Japanese Yen. As a result, one Yen would buy less than it used to, so firms would have no choice but to push prices up.

Another policy that has already been practiced in Japan is the use of negative interest rates – essentially, savers now have to pay to store their money in a bank account.

What Makes Japan so Safe?

This is another short-run policy that works by making it expensive to save, incentivizing households to spend their money rather than hold on to it, thereby creating inflationary pressures in the economy.

However, as previously mentioned, there is a lot more to Japan’s deflation problem than what is presented at surface level, and for any real change to be done, more long-run, structural, demographic changes need to occur.

Demographic changes are undoubtedly much more difficult to implement, but countries like China and Singapore have had previous success with similar policies in the past.

Japan could follow suit by increasing the retirement age so people are inclined to stay in the workforce for longer, by encouraging and facilitating the import of foreign talents, by investing in and leaning on new technologies for productivity, by subsidizing the training needed to get the long-term unemployed participating in the workforce again, or even by offering incentives to its citizens to have more children.

Such structural policies and changes, however, no longer lie in the hands of the Japanese central bank; rather, it is up to the Japanese government to lead such projects for the sake of their economy.

Returning to the Forefront: Japanese Automobile Automation

Written by Adele Teo

Edited by Calvin Ma & Alexander Fleiss

Sources:

Liu, Y. and Westelius, N., 2016. The Impact Of Demographics On Productivity And Inflation In Japan. [ebook] International Monetary Fund. Available at: <https://www.imf.org/external/pubs/ft/wp/2016/wp16237.pdf> [Accessed 9 December 2019].

Wall Street Journal, 2015. A Japanese Lesson In Deflation For Europe. Available at: <https://www.youtube.com/watch?v=HvppJ-MhE6A> [Accessed 10 December 2019].

The Economist. 2018. Japan’S Habits Of Overwork Are Hard To Change. [online] Available at: < https://www.economist.com/asia/2018/08/02/japans-habits-of-overwork-are-hard-to-change > [Accessed 12 December 2019].

Yoshitomo, T., 2017. Taking Stock Of Suicide In Japan. [online] nippon.com. Available at: <https://www.nippon.com/en/currents/d00266/taking-stock-of-suicide-in-japan.html> [Accessed 12 December 2019].

Japan’s Chronic Deflation

Great Inflation : How Economic Turmoil led to the modern Federal Reserve (rebellionresearch.com)