Japanese Deflation Reviewed

In monetarist theory, deflation must be associated with either a reduction in the money supply, a reduction in the velocity of money or an increase in the number of transactions. But any of these may occur separately without deflation. It may be attributed to a dramatic contraction of the money supply, or to adherence to a gold standard or other external monetary base requirement.

 However, deflation is the natural condition of hard currency economies when the supply of money is not increased as much as positive population growth and economic growth. When this happens, the available amount of hard currency per person falls, in effect making money more scarce; and consequently, the purchasing power of each unit of currency increases. Deflation occurs when improvements in production efficiency lower the overall price of goods. Competition in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods. When this happens, consumers pay less for those goods; and consequently deflation has occurred, since purchasing power has increased.

The effects of deflation are:

 1.Decreasing nominal prices for goods and services

 2.Increasing buying power of cash money and all assets denominated in cash terms

 3.May decrease investment and lending if cash holdings are seen as preferable (aka hoarding)

 4.Benefits recipients of fixed incomes

During severe deflation, targeting an interest rate (the usual method of determining how much money to create) may be ineffective, because even lowering the short-term interest rate to zero may result in a real interest rate which is too high to attract credit-worthy borrowers. Thus the central bank must directly set a target for the quantity of money (called "quantitative easing") and may use extraordinary methods to increase the supply of money, e.g. purchasing financial assets of a type not usually used by the central bank as reserves (such as mortgage backed securities). Before he was Chairman of the United States Federal Reserve, Ben Bernanke claimed in 2002, "...sufficient injections of money will ultimately always reverse a deflation", although Japan's deflationary spiral was not broken by this very sort of quantitative easing.

JAPAN

Deflation started in the early 1990s. The Bank of Japan and the government tried to eliminate it by reducing interest rates and 'quantitative easing', but did not create a sustained increase in broad money and deflation persisted. In July 2006, the zero-rate policy was ended.

 Systemic reasons for deflation in Japan can be said to include:

JAPAN, one of the great exporting nations, usually runs a trade deficit with, of all places, Switzerland. Why? Ask Rolex. Japan also buys more from France and Italy than it sells there. Why? Bordeaux, Brie, mascarpone and Armani, to name a few expensive vices. In Japan such delicacies are mostly immune to deflation, while prices of everyday goods like cars, electronic goods and clothes tumble. Why then do Japanese firms continue to churn out the latter, even though margins are low? And could this help explain Japan's persistent deflation problem?

These questions preoccupy Kosuke Motani, author of “The Real Face of Deflation”. In this book's first seven months in print, 500,000 copies have been sold, including one to Naoto Kan, the prime minister. Mr Motani argues that deflation in Japan is not so much a monetary problem as a structural one linked to bad business decisions and demography.

 If Japanese firms produced new types of luxury goods, he believes, they could unleash pent-up demand among Japan's growing, and wealthy, ranks of old people and pay higher wages to Japan's shrinking, and relatively poor, youth. Unsurprisingly, his views have won a sympathetic hearing at the Bank of Japan (BoJ), which has often been accused of failing to do enough to reverse falling prices.

 

Japanese Finance Minister Taro Aso said the government is imitating his Depression-era predecessor, Korekiyo Takahashi, who told the Bank of Japan (8301) to underwrite government debt to fund deficit spending.

“There is no one in the government, the bureaucracy or the BOJ who has experience in anti-deflation policy,” Aso said yesterday in an interview on NHK television. “We can only learn from history,” he said, adding that the new administration is looking to Takahashi’s example

As finance minister in 1932, Takahashi increased fiscal spending by 34 percent, doubled bond issuance and instructed the BOJ to underwrite government debt, according to a report by the Japan Center for Economic Research. While the effort helped end deflation and boost growth, Takahashi made enemies in the military when he later attempted to rein in spending. He was assassinated in 1936.

 

Takahashi “brilliantly rescued Japan from the Great Depression through reflationary policies,” Federal Reserve Chairman Ben S. Bernanke said in a speech in 2003. His policy package increased the fiscal deficit, depreciated the currency and expanded the money stock, with robust growth and mild inflation for the five years from 1933, according to a research paper co-authored by Masato Shizume, an economist working for the BOJ.

 

“If a central bank starts to underwrite government bonds, there may be no problems at first, but it would lead to a limitless expansion of currency issuance, spur sharp inflation and yield a big blow to people’s lives” and the economy, as has happened in the past, BOJ Governor Masaaki Shirakawa said in 2011. The central bank took the step in the 1930s because the debt market was “very immature,” Shirakawa said.

Under Takahashi’s initiative, the BOJ’s underwriting continued for 14 years until the end of World War II, with the ratio of bonds bought by the central bank peaking in 1933 at 89.6 percent, according to a 2001 paper by the central bank.

Now, the BOJ purchases government bonds through the secondary market, and includes the securities in its 76-trillion yen asset-purchase program.

Since taking office in December, Abe’s government has announced fiscal stimulus to boost an economy in recession, with the BOJ agreeing to a 2 percent inflation target requested by the government and announcing open-ended asset purchases in a bid to stop more than a decade of falling prices.

Aso told lawmakers in Parliament today that the government will try to maintain trust in its fiscal management.