Soaring prices is a common
phenomenon in Nepal, with an average of 8% inflation. We are tired of
increasing prices. So, when we hear of deflation (opposite of inflation), we
might think it as a positive phenomenon, but actually it is not! which we will
discuss later in this article. Inflation refers to general increase in price
level and Deflation indicates a persistent decrease in the price level.
Disinflation might be confusing with deflation. However, disinflation is the
decrease in the inflation rate, and when the inflation rate reaches zero and
even falls below zero, it is referred to as deflation. Deflation has been a
common phenomenon in most of the European countries and Japan. Japan has been
facing deflation since 1990s and Japanese government has experimented all kind
of policies to recover its economy out of deflation since then. However, the
recovery seems to be difficult for Japan. The decade of deflation is also known
as "Lost Decade" in Japan. Lost Decade in the sense that the economy
has remained stagnant since then. So, why the decrease in prices matter for the
economy. We will look at the case study of Japan.
How the deflation started at
all?
Deflation was created since
1990s, when the real estate bubble crashed. The soaring prices came down and it
has not been able to catch up the race since then(except in 2006, when the
signs of recovery was seen but couldn’t last long). Japan had experienced an
economic miracle during the period of 1950s to 1970s. The growth rate was
around 10% per year. The globalization had allowed the Japanese trade to bloom
and its human resources were complimented for their hard work and dedication
towards the expansion of the Japanese economy. It was boosted by the stable
political leadership during the period.
The Plaza Accord of 1984, decided
to undervalue dollar against yen as yen was highly undervalued hurting the
export of other countries. The appreciating yen led to expensive exports of
Japanese goods and thus, pushed the country to mild recession. To counter it,
the Japanese government adopted an expansionary monetary policy, cutting the
interest rates to encourage investments. The appreciating yen coupled with
expansionary monetary policy led to surge in the prices. The cross-share
holdings of oligarchic Japanese business community, corrupt bureaucrats
inclined to bankers and businesspeople, manipulative financial data and
reckless lending practices were among the reasons of soaring prices.The stock
price index and the land price index quadrupled from 1983 to 1989. The stock
price index (Nikkei 225) rose from 10,000 yen at the end of 1983 to near 40,000
at the end of 1989. It was rumoured that the land underneath the Tokyo Imperial
Palace to have been worth as much as the entire state of California in the same
year.
Bank of Japan is often criticized
for its expansionary policy during the bubble creation phase. When the Central
Bank finally tightened the monetary policy in 1989, stock prices declined by
50% in 1990 and by 60% by 1992. The real estate price also saw the similar
decline. Nikkei Index is being traded below 20,000 even till date. The worst
state policy after 1990s was zombie lending, whereby state failed to recognize
the unhealthy firms and protected them with bail-outs, thus distorting the
health of the economy.
Japanese economy since then has
been into a deep recession, with falling prices, wage, employment and
appreciating yen.
How deflation affects the
economy?
An
economic growth is possible with an increased labour force, increased
employment, increased production, increased sales and increased wages. However,
when deflation enters the economy, the
reverse happens. Hoarding money will be beneficial to people, rather than any
kind of investments. Moreover, the borrower will be at loss, as the real
principle payment will be increased. People will thus delay their purchases
with the expectation of further decrease in the value. The decline in
consumption, then will affect the sales, corporate profits and employment
situation. The following figure explicitly explains, why deflation is bad for
economy. And this is happening in Japan right now. Japan has been caught in a
deflationary spiral.
After the burst of the bubble,
Japanese economy needs some strong stimulus to recover its economic growth.
However, there are some structural phenomenons to fuel the deflation mentioned
as below:
Demographics: Japan has an
ageing demographics. The working labor force is decreasing annually. In 2015,
the people above 65 years of age occupied 26.7% of the total population. The
population beween the age of 15-64 accounts for 60.8% of the total population
and is rapidly declining. With an aging population, the productive workforce
has to work much harder just to maintain status quo. The government expenditure
increases on the pension funds and retirement benefits. And the aging
population tend to spend less. The deflation of the Japanese economy caused by
the slow spending will aggravate in this case. The Japanese government needs to
welcome more immigrants into the country to boost the economy. However, the
Japanese government seems very reluctant towards immigrants till date.
Appreciating Japanese currency
and slow exports: Japanese currency has been appreciating in spite of
slowing economy. With Plaza Accord, the currency was devalued against US $.
Hoarding of yen has resulted to its appreciation creating high demand. Yen is
basically considered to be a safe haven currency. Thus, with Brexit, European
currency and even with the Trump's victory in US election led to the
appreciation of yen. So, how appreciation of yen slows the economic growth.
What Central Bank of Japan and
government has been doing to tackle deflation?
Central Bank of Japan has adopted
numerous policy to tackle deflation as "inflation/deflation is considered
to be a pure monetary phenomenon". Japan was the first economy to start
the quantitative easing program by buying
the government bonds. Through quantitative easing, it had tried to
inject money in the market, when the zero interest policy could not recover the
economy. In 2016, also Bank of Japan has declared that it would buy government
bonds worth of 80 trillion yen per annum. The Bank of Japan has interestingly
also adopted the Negative Interest Rate, whereby the banks have to pay the
Central Banks for its deposits. This unconventional policy was also adopted to
encourage banks for lending. The bank has targeted an inflation rate of 2%,
which seems difficult to achieve as it hovers around negative to near zero.
Bank of Japan buys the Exchange trade funds to facilitate the depreciation of
yen and to stimulate the economy. With Shinzo Abe elected as Prime Minister in
Japan, the Abenomics has been a new economic term. Abenomics has three arrows:
Arrow 1: Monetary Easing, Arrow 2: Fiscal Spending Arrow 3: Economic growth
(Structural Reforms).
All these experimental programs
of Bank of Japan has yielded results for the short term, but has failed to
sustain for the longer period. The recovery was considerably hampered by the US
Financial crisis of 2008. And again the economy is slowing down in 2016. Moreover,
the Japanese public debt is also soaring, with its expansionary policy.
Lessons Learnt from the Japanese
Economy:
The government should act
promptly in the time of crisis as markets may not resurrect by itself. The
reactions of Central Bank is often criticized as "too little; too
late". There were some clear policy
mistakes as well. The accounting system of Japanese Banks were also faulty to
create the bubble. This clearly indicates the close supervision of banks and
need of efficient accounting system. Moreover, the corruption in the politics
also fueled the bubble. Thus, the government and the Central Bank always needs
to be an independent analyst rather than a puppet of businessmen and bankers.
Central Bank of Japan has been applying unconventional monetary policies and
every possible means to revive the economy lately. In fact, there is no experiment
left for the Central Bank of Japan to adopt for the economic stimulus. In continuation with the expansionary
monetary policy, the structural problem of the Japanese economy: Demographics
needs to be addressed, through revised immigration policies.
