Japan’s Resurgence: Inflation reaching 2.2%

Japan’s Resurgence: Inflation reaching 2.2%

Japan’s Resurgence: Inflation reaching 2.2%

Japan’s stock index achieved a significant milestone last week reaching its first new high in 34 years, reflecting Japan’s resurgence as an exciting economy – revitalizing business and investor confidence.

The recent surge in Japan’s Nikkei stock index signals the nation’s remarkable economic resurgence after decades of stagnation, coinciding with signs of overcoming deflation. The stock index achieved a significant milestone last week by reaching its first new high in 34 years, reflecting Japan’s resurgence as an exciting economy.

This development coincides with the increasing signs that Japan has overcome deflation, with January’s inflation reaching 2.2%, marking the 22nd consecutive month above 2%. Additionally, wage growth has shown improvement. While this seems to validate the prevailing belief that deflation was a key factor in Japan’s prolonged economic stagnation, it may be premature to draw such conclusions.

The detrimental effects of deflation have been challenging to ascertain, and the advantages of maintaining low but positive inflation may be nuanced. Consumers are often perplexed by the notion that deflation is inherently negative. In contrast, in the United States, where prices have steadily risen since 2021, many individuals, including economists, wouldn’t oppose a slight decline in prices.

However, persistent deflation poses significant challenges, as witnessed in the U.S. during the period from 1929 to 1933 when prices plummeted by 27%. This situation can lead to difficulties for debtors in repaying loans, potentially resulting in reduced spending or defaults, thereby threatening the stability of the financial system.

Despite conventional wisdom attributing Japan’s economic woes to deflation, the exact harms of this phenomenon remain elusive. The narrative of deflation as the sole culprit overlooks underlying structural factors such as demographic shifts and globalization which have exerted downward pressure on prices and wages.

Even modest deflation can theoretically impede economic growth. Central banks typically stimulate spending by reducing nominal interest rates below the inflation rate, effectively making the real cost of borrowing negative. However, this strategy becomes exceedingly difficult when inflation itself is negative.

Renowned economists like future Federal Reserve Chair Ben Bernanke contended that addressing deflation was crucial for Japan’s economic recovery. Adjusting for demographic changes, Japan’s economic performance has been commendable, comparable to other developed nations. Despite aggressive monetary policies by the Bank of Japan, including zero to negative interest rates and asset purchases, the evidence linking deflation to economic stagnation remains inconclusive.

The origins of deflation in Japan trace back to the bursting of property and stock–market bubbles in the early 1990s, leading to losses at banks and a subsequent decline in lending capacity. This trend resulted in negative inflation starting in 1999.

Japan experienced a decline in its working-age population growth in the early 1990s, coinciding with the conclusion of its post-World War II phase of catching up with other developed nations. Concurrently, industries began relocating productions to countries with lower labor costs, exacerbating the structural downward pressure on prices, wages, and growth.

Nevertheless, Japan’s performance, when adjusted for its shrinking population, has been commendable. Between 1991 and 2019, its output per hour of work increased by 1.3% annually, a rate slower than that of the United States but faster comparable to Canada, France, Germany, Britain, Italy, and Spain according to Jesús Fernández-Villaverde, Gustavo Ventura and Wen Yao.

According to the University of Tokyo economist Tsutomu Watanabe, Japan has experienced unusually infrequent changes in relative prices over the period from 1995 to 2021.  More than half of the products surveyed showed no price changes from year to year, a phenomenon not solely attributed to lower average inflation but also to deviations to lower averages that were much smaller compared to other countries.

The potential harm was in the behavioral shifts among investors, companies, and the public. Anyways inflation may be revitalizing business and investor’s confidence, despite these positive indicators, Japan’s growth last year remained similar to pre-pandemic levels and turned slightly negative in the third and fourth quarters, leading to a technical recession. Additionally, wages have failed to keep pace with inflation and Prime Minister Fumio Kishida’s approval ratings have plummeted.

However, the actual benefits of inflation are yet to be felt by ordinary people as wage growth continues to lag behind rising prices, and economic growth remains modest. Japan may have conquered deflation, but the journey toward sustained prosperity is far from over. 

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