The Bank of Japan Act states that the monetary policy should be "aimed at achieving price stability, thereby contributing to the sound development of the national economy." In January 2013 the BOJ set this price stability target at 2% in yearly rate of change in the consumer price index (CPI), and "has made a commitment to achieving this target at the earliest possible time" (that's a nice way to set a deadline). Pretty similar to the ECB's mandate.
Japan's one and only real threat on price stability is deflation. Actually if you want to simplify the story, you could say that Japan's sole true economic problem is deflation. Since the mid 1980's, Japan has tried hard to fight deflation, with a round of heavy interest rate cuts between 1985 and 1988, slain from over 8% down to 0%.
Highly educated and serious people with cuff-links and Italian shoes have identified a number of causes for Japan's never-ending deflation issue.
First they said that the Japanese save too much. It is true that there is a general tendency to invest more in life insurance and pension funds than buying stuff on credit. But this is a lot less true for the generations born after the postwar baby-boom.
Even if we assuming that consumption is low in Japan, is it possible that a population investing in low-risk saving instruments cause deflation ?
Maybe it is. Our experts simply said that a high saving rate leads to low consumption. But looking at the World Bank numbers, Japan's consumption rate is similar to Western European countries. And if you have a chance to travel to Japan you will easily notice that consumption and consumer credit are doing pretty good. The picture to the right is a advertisement that you will see everywhere in the subway of Tokyo and every major city : borrowing 50 000 dollars at 18% is easier than 1 2 3 in Japan. And next to these ads you will see those of lawyers proposing free counseling for people who can't pay their debts.
Moreover, it is widely known that Japanese banks and funds invest mainly in yen-denominated instruments, thus creating demand for the domestic currency. For one year, the Bank of Japan has been running the world's largest Quantitative Easing (aka money printing) program, buying 100% of newly issued governments bonds (JGB). But all this freshly printed money flowing into the Japanese financial ecosystem is not helping Prime Minister Abe in his quest to fight deflation.
Japan is in what they call a "liquidity trap", a situation where interest rates are at zero but where people keep saving anyway. If you think about it, would you decide to spend all your savings just because rates are low ? What's true is that low rates in Japan have had a positive effect on consumption in that you can buy a house with a mortgage rate of 1% or less.
Such a liquidity trap situation is said to cause a fall in the velocity of circulation of money and can lead to deflation.
Here's how it works: if the interest rates on financial assets are high, people will not want to hold cash, they rather try to exchange it for goods or financial assets: velocity is high and money demand is low, causing inflation. On the contrary, if interest rates are low, velocity is low and money demand is high, causing deflation. In such a case, increasing the money supply will not necessarily cause inflation...This is where Japan is right now.
A second probable cause was the consumption tax hike in 1997, which killed nascent signs of recovery. If that's true, then Abenomics could be dangerous -the plan is to raise the tax to 10% (from 5% last year, 8% this year). A sales tax hike can be used to artificially inflate consumer price levels. If you strip out the impact of Abe's tax hike in March, consumer prices grew 1% versus the 2.7% news headline number. But the actual impact of such a hike is quite obvious:
The last mentioned cause is the Yen appreciation against the dollar. This is hardly being developed, and for some reason few detail the impact of the Plaza Accord.
...To be continued in Part 2...
Japan's one and only real threat on price stability is deflation. Actually if you want to simplify the story, you could say that Japan's sole true economic problem is deflation. Since the mid 1980's, Japan has tried hard to fight deflation, with a round of heavy interest rate cuts between 1985 and 1988, slain from over 8% down to 0%.
Highly educated and serious people with cuff-links and Italian shoes have identified a number of causes for Japan's never-ending deflation issue.
First they said that the Japanese save too much. It is true that there is a general tendency to invest more in life insurance and pension funds than buying stuff on credit. But this is a lot less true for the generations born after the postwar baby-boom.
Even if we assuming that consumption is low in Japan, is it possible that a population investing in low-risk saving instruments cause deflation ?
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| Consumer credit: 0% for 30 days, then 4.7% to 18% |
Moreover, it is widely known that Japanese banks and funds invest mainly in yen-denominated instruments, thus creating demand for the domestic currency. For one year, the Bank of Japan has been running the world's largest Quantitative Easing (aka money printing) program, buying 100% of newly issued governments bonds (JGB). But all this freshly printed money flowing into the Japanese financial ecosystem is not helping Prime Minister Abe in his quest to fight deflation.
Japan is in what they call a "liquidity trap", a situation where interest rates are at zero but where people keep saving anyway. If you think about it, would you decide to spend all your savings just because rates are low ? What's true is that low rates in Japan have had a positive effect on consumption in that you can buy a house with a mortgage rate of 1% or less.
Such a liquidity trap situation is said to cause a fall in the velocity of circulation of money and can lead to deflation.
Here's how it works: if the interest rates on financial assets are high, people will not want to hold cash, they rather try to exchange it for goods or financial assets: velocity is high and money demand is low, causing inflation. On the contrary, if interest rates are low, velocity is low and money demand is high, causing deflation. In such a case, increasing the money supply will not necessarily cause inflation...This is where Japan is right now.
A second probable cause was the consumption tax hike in 1997, which killed nascent signs of recovery. If that's true, then Abenomics could be dangerous -the plan is to raise the tax to 10% (from 5% last year, 8% this year). A sales tax hike can be used to artificially inflate consumer price levels. If you strip out the impact of Abe's tax hike in March, consumer prices grew 1% versus the 2.7% news headline number. But the actual impact of such a hike is quite obvious:
higher prices with same revenue = less consumptionThis is what's happening. Isetan, a major department store chain, reported a double-digit decline in sales in the days following the hike. Sales of new homes and cars have dropped sharply as well -over 13% year-on-year. If you are in a liquidity trap and instead of boosting consumption you raise the tax, then you're offsetting the potential inflationary impact of QE. We know that the 1997 tax hike was followed by a recession and aggravated deflation.
The last mentioned cause is the Yen appreciation against the dollar. This is hardly being developed, and for some reason few detail the impact of the Plaza Accord.
...To be continued in Part 2...
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