Commentary
Japan has always been seen as unique compared to other nations. In the early 1990s, it faced prolonged deflation and zero interest rates, but now it is contemplating raising interest rates while other countries are considering cutting them.
The main factor behind this shift is a significant and prolonged currency depreciation. Despite this, Japan’s stock market is thriving, reaching historical highs. However, despite signs of economic recovery, both the market and policymakers at the Bank of Japan (BoJ) do not view inflation in the country as high.
From a cyclical perspective, the focus should be on the direction of growth rather than the level. For an aging country like Japan, low real growth and inflation are expected. This is more of a structural issue rather than a cyclical one. Although statistical filters can be used to detrend the data, simple measures like year-over-year growth can capture cyclical movements adequately, especially when the trend component is minimal.
The chart accompanying this article illustrates the year-over-year growth of two key variables: gross domestic product (GDP) and the consumer price index (CPI), representing real quantity and nominal price, respectively. Normally, in the absence of adverse supply shocks like a pandemic or war, demand shocks should lead to a positive correlation between the two variables. In Japan’s case, there is a lag in CPI compared to GDP, but overall, they move in the same direction.
Historically, a 1.5 percent change in GDP growth has resulted in a 1 percent change in CPI growth. There have been periods where inflation was below or above expectations. In the early 2000s, inflation was lower than anticipated, while in recent years, it has been higher. These deviations from the norm require further analysis.
The low inflation in the 2000s was attributed to debt deflation, a well-known phenomenon. However, the recent higher inflation has puzzled many analysts. Despite unsustainable GDP growth, inflation should have decreased, but it hasn’t. While factors like COVID-19 and geopolitical tensions initially contributed to supply shocks, these effects have waned. Therefore, the most likely remaining cause is excessive monetary easing.
Extended periods of negative real interest rates and currency depreciation typically lead to high inflation. Although Japan’s current inflation levels are not high compared to other countries, they are significant relative to GDP growth. This suggests that the BoJ may be repeating past mistakes by tightening monetary policy too late after easing too late in the 1990s.
The abnormalities in Japan’s economy seem to be more a result of policy errors rather than exceptional economic conditions.
Opinions expressed in this article are those of the author and do not necessarily reflect the views of The Epoch Times.
