More deflation in Japan

[Puppycow]

Japan prices continue record fall

Japan's core consumer prices dropped 2.4% in August year-on-year, the fourth successive month of record falls.
. . .
The Bank of Japan has already forecast deflation to last until the year to March 2011 and is expected to extend its deflation forecast by another year in its next set of forecasts due out in late October.

More deflation through 2012?

How will it end? Why can't the central bank make it end by just printing more money? I don't understand why it's difficult to end deflation? Can't they even kill two birds with one stone: Give the money to the government to pay down the national debt and kill deflation with the same policy?

 

[Puppycow]

Another article

Companies from Fast Retailing Co. to Sony Corp. are lowering prices to attract consumers who face record unemployment and plunging wages. A return to the deflation that the economy only shook off in 2005 may weigh on growth as consumers and companies cut back spending in anticipation that prices will keep falling.

“We’ll soon start to see that there isn’t enough domestic demand to push up wages,” said Kyohei Morita, chief economist at Barclays Capital in Tokyo. “As households’ spending power falls, there’s concern that this deflation will lead to further deflation -- in other words, that we’ll enter into a deflationary spiral.”

The yen’s rally to an eight-month high also threatens to stunt the recovery by making Japanese exports more expensive and eroding the value of repatriated profits. Japan’s currency traded at 89.96 per dollar at 9:53 a.m. in Tokyo from 89.63 before today’s report and rose as high as 88.24 yesterday, the strongest since January.

Record Unemployment

A report this week will show the jobless rate reached 5.8 percent last month, topping July’s postwar record, according to a Bloomberg News survey of economists. Wages probably slid for a 15th month in August, figures are expected to show tomorrow.

 

[Francesca R]

How will it end? Why can't the central bank make it end by just printing more money?

Because while inflation is apparently "always and everywhere a monetary phenomenon" it is final demand that matters to an economy, and that is sometimes beyond the influence of monetary policy. That is a view about Japan anyway. The Bank of Japan did "print money" (which means it bought government bonds and therefore added reserves to the country's banking system) between 2001 and 2006. Arguably, since many of Japan's banks, and their borrowers (firms) were pretty undercapitalised (too many impaired assets for their capital base), the addition of reserves through quantitative easing made little or no difference to their willingness and effective ability to lend and borrow.

This phenomenon is the textbook "pushing on a string" scenario that is attributed to JM Keynes. That is why the 2008 deflationary spiral that has affected much of the world has been responded to with fiscal policy (government spending and in particular state-sponsored bank recapitalisations) as well.

I don't understand why it's difficult to end deflation?

It is easier to end deflation than it is to increase private sector demand. But runaway inflation not driven by economic growth is not an outcome anybody wants. It would be erroneous to assume that just as long as you can get Japan to print a positive CPI increase, everything else will sort itself out.

Can't they even kill two birds with one stone: Give the money to the government to pay down the national debt and kill deflation with the same policy?

That is sort-of what happens when the BOJ buys Japanese government bonds. But it is lending to the government not giving to them--the JGBs are not cancelled ("forgiven") and the government remains in the central bank's debt, with the result that the BOJ's balance sheet grows bigger. It may appear semantic, but the government would need to default on JGBs held by the BOJ for it to reduce the public debt, absent an increase in government revenue (which would be produced by tax receipts or selling public assets). And if it defaulted on those, you can be pretty sure that holders of all the other JGBs outstanding would change their minds about how valuable they are pretty fast.

PS--"Core" inflation in Japan does not exclude energy items, unlike several other countries' statistics. Ex energy, the CPI is still negative but the swing over the last year is a bit less dramatic (-0.9y/y). It has been negative most of the time since mid 1998.

 

[Puppycow]

Thanks for the response Francesca.

Because while inflation is apparently "always and everywhere a monetary phenomenon" it is final demand that matters to an economy, and that is sometimes beyond the influence of monetary policy.

I take it that you are not in agreement with Friedman's quote then. It agree that it doesn't seem to stand up to the evidence.

It is easier to end deflation than it is to increase private sector demand. But runaway inflation not driven by economic growth is not an outcome anybody wants. It would be erroneous to assume that just as long as you can get Japan to print a positive CPI increase, everything else will sort itself out.

Are you saying that the only way to end deflation without increasing private sector demand is to cause "runaway" inflation? I certainly don't want that, but even without economic growth or demand growth, I would still prefer 1-3% inflation over 1-3% deflation. But I suppose that if it's a choice between mild deflation and hyperinflation I prefer the former. I just wish I owned my house free and clear because deflation makes the real value of my mortgage debt increase. Meanwhile, my income this year is less than last year, but my mortgage payments haven't changed. If they predict deflation though 2012, that suggests to me that it may continue indefinitely and that deflation is now normal in Japan. Wages have fallen for 15 straight months.

That is sort-of what happens when the BOJ buys Japanese government bonds. But it is lending to the government not giving to them--the JGBs are not cancelled ("forgiven") and the government remains in the central bank's debt, with the result that the BOJ's balance sheet grows bigger. It may appear semantic, but the government would need to default on JGBs held by the BOJ for it to reduce the public debt, absent an increase in government revenue (which would be produced by tax receipts or selling public assets).

Is the BOJ not allowed to forgive the debt or payments on the debt? Obviously the government cannot default, but if the BoJ didn't collect any payments on the bonds it holds, or disposed of them, the debt would go away. I am curious how the government is going to pay those bonds if it has to pay them in full or if interest rates return to normal levels. I assume that interest rates will remain at near zero as long as there is deflation.

 

[Ryokan]

Japanese prices falling is good for me! So I don't care

Mostly joking, in the grand scheme of things, I of course care. But it's not neccesarily a bad thing. Lower prices means higher consumption, domestic and abroad, and in the long term it will probably fix itself.

 

[Francesca R]

I take it that you are not in agreement with Friedman's quote then. It agree that it doesn't seem to stand up to the evidence.

Actually I am (in agreement). But "getting positive inflation" is not the end goal, getting growth is:

The Bank of Japan Act states that the Bank's monetary policy should be "aimed at achieving price stability, thereby contributing to the sound development of the national economy."

Price stability is important because it provides the foundation for the nation's economic activity. In a market economy, individuals and firms make decisions on whether to consume or invest, based on the prices of goods and services. When prices fluctuate, individuals and firms find it hard to make appropriate consumption and investment decisions, and this can hinder the efficient allocation of resources in the economy. Unstable prices can also distort income distribution. For example, in times of high inflation, people holding only financial assets whose value is fixed in nominal terms, such as bank deposits, will suffer a decline in the value of those assets in real terms.

http://www.boj.or.jp/en/type/exp/seisaku/expseisaku.htm#01

Are you saying that the only way to end deflation without increasing private sector demand is to cause "runaway" inflation?

No--that action to end deflation that is not likely to be accompanied by real growth is harder to do, and risks unstable, uncontrolled inflation.

I certainly don't want that, but even without economic growth or demand growth, I would still prefer 1-3% inflation over 1-3% deflation. But I suppose that if it's a choice between mild deflation and hyperinflation I prefer the former.

Most of the public debate appears to be that only the latter choice is what policymakers fear is facing them.

Criticism of this stance (and there has been plenty, but it has quietened down massively since other countries have slid into the same unenviable trap) tends to be something like "Government incompetence is what presents this dichotomy . . . if the ministry of finance had done more to kill/save zombie banks and shadow-banks in the 1990s, then it would have been much easier for monetary policy to work". The truth is probably something in between

I just wish I owned my house free and clear because deflation makes the real value of my mortgage debt increase. Meanwhile, my income this year is less than last year, but my mortgage payments haven't changed. If they predict deflation though 2012, that suggests to me that it may continue indefinitely and that deflation is now normal in Japan. Wages have fallen for 15 straight months.

Yes that's why it's called a liquidity trap, and that's why deflation causes defaults. On the positive side, you can buy stuff with less money. (Particularly US stuff)

Is the BOJ not allowed to forgive the debt or payments on the debt? Obviously the government cannot default, but if the BoJ didn't collect any payments on the bonds it holds, or disposed of them, the debt would go away.

I've never actually tried to find out and have assumed that this is not possible. Certainly a statement by a central bank that it was tearing up its government bond assets would be viewed by the market as a default, and would therefore do all sorts of damage. So it is not at all viable.

I am curious how the government is going to pay those bonds if it has to pay them in full or if interest rates return to normal levels. I assume that interest rates will remain at near zero as long as there is deflation.

In the limit, governments have to repudiate debt. If they borrow heavily abroad, or if their domestic (private) savings are very low, or if the economy is simply tanking, this is more likely and it happens. Some think it is "increasingly likely" in Japan. The government lost its AAA credit ratings from Moodys and S&P several years ago.


ETA--Barron's story needs subscription, sorry.

 

[Francesca R]

Lower prices means higher consumption, domestic and abroad, and in the long term it will probably fix itself.

I think the yen's appreciation against just about every currency in the last couple of years more than offsets the domestic deflation.

ETA--And domestically, I forgot to add that the expectation of even lower prices later delays consumption.

 

[SLS]

ETA--And domestically, I forgot to add that the expectation of even lower prices later delays consumption.

Has anyone ever shown this to be true, from a consumer standpoint? I don't rush out to buy milk because I'm worried about the dollar inflating 2-4%/year and I'm certainly not going to wait six months to buy it because it might be cheaper. Deflation doesn't compare to the changing prices of technology due to new innovations. What kinds of purchases are delayed?

I assume Japan's CPI index like the US's includes a housing component, right? Couldn't the continued decline of real estate values account for the whole "deflation" they are seeing?

 

[oldhat]

What kinds of purchases are delayed?

First to go are usually major capital investments, like heavy machinery, robots, trucks, boats, etc. Then it trickles down to big ticket consumer goods like cars and TVs, then smaller items.

If you can save $5000 on a $150,000 crane if you wait for 3 months, that makes sense.

 

[SLS]

Correct me if I'm wrong but I'm almost certain major capital goods aren't factored into the CPI.

A consumer price index (CPI) is a measure estimating the average price of consumer goods and services purchased by households. A consumer price index measures a price change for a constant market basket of goods and services from one period to the next within the same area (city, region, or nation).

In America we saw the CPI take a dive almost exclusively because housing prices collapsed.

You have to be very careful how you use the words deflation and inflation. There is no perfect method for measuring price inflation/deflation. You can have monetary inflation and price deflation at the same time. That seems to be happening now in the US. I'm just wondering if the situation in Japan is in some way similar.

 

[Puppycow]

Japanese prices falling is good for me! So I don't care

Mostly joking, in the grand scheme of things, I of course care. But it's not neccesarily a bad thing. Lower prices means higher consumption, domestic and abroad, and in the long term it will probably fix itself.

How is it good for you in Norway?

Perhaps it will fix itself eventually, but there are worrisome possibilities. Fransesca mentioned the possibility of a debt default.
The longer deflation continues, it seems, the greater this possibility becomes, no? Here's what's inevitable: Japan's population is shrinking and greying. Japan's labor force is shrinking. Unless per capita productivity increases faster than the labor force shrinks, real GDP seems likely to decrease. Tax revenues come from income and consumption. If income and consumption slope down, tax revenues will go down unless tax rates are increased. Meanwhile the debt increases every year because the budget is not balanced. And yet, the yen gets stronger and stronger for some reason. Am I missing something?

 

[Puppycow]

In the limit, governments have to repudiate debt. If they borrow heavily abroad, or if their domestic (private) savings are very low, or if the economy is simply tanking, this is more likely and it happens. Some think it is "increasingly likely" in Japan. The government lost its AAA credit ratings from Moodys and S&P several years ago.

Doesn't seem to bother the currency markets yet. Is is because the currency markets are wrong? Should a loss of credit rating affect exchange rates?

 

[Puppycow]

Correct me if I'm wrong but I'm almost certain major capital goods aren't factored into the CPI.

True, but they are part of the real economy nonetheless.
Capital goods are made by companies that employ people who purchase consumer goods. If they have to lay off workers, that will decrease consumer demand.
Also, I think they might be included in another important indicator: PPI

 

[Beerina]

How is it good for you in Norway?

Perhaps it will fix itself eventually, but there are worrisome possibilities. Fransesca mentioned the possibility of a debt default.
The longer deflation continues, it seems, the greater this possibility becomes, no? Here's what's inevitable: Japan's population is shrinking and greying. Japan's labor force is shrinking. Unless per capita productivity increases faster than the labor force shrinks, real GDP seems likely to decrease. Tax revenues come from income and consumption. If income and consumption slope down, tax revenues will go down unless tax rates are increased. Meanwhile the debt increases every year because the budget is not balanced. And yet, the yen gets stronger and stronger for some reason. Am I missing something?

Not only that, what's already borrowed becomes worth more with deflation. The government may take in the same amount of money, proportionally, "loaves-of-breadwise", but it will now take 20% more "loaves" to pay the same amount in debt interest. That's exaggerated but basically the math of it.

Indeed, historically, governments erase a lot of debt value through inflation, a process called "monetizing" the debt. Without paying down a single dime, in 10 years or less they can halve the value of what they've borrowed, "buying loaves-of-bread-wise". Of course, that's grotesquely inefficient use of money, paying interest all these years, but talk to your congressman at the next election if you don't like it. I'll just point out that, without any debt, we'd have about $400 billion extra per year to spend without borrowing a single dime.

 

[Puppycow]

I'll just point out that, without any debt, we'd have about $400 billion extra per year to spend without borrowing a single dime.

This is true if we could wave a magic wand and make the debt disappear, but keep all the stuff we bought with that debt. If we had to give up everything that was purchased with that debt, it's not so certain we'd be better off.

ETA: In Japan's case, some of that was clearly wasteful spending little better than digging ditches and filling them back up.
Construction freeze on Japan dam marks end of era

NAGANOHARA, Japan — Giant gray pylons loom over this hot springs town — part of a $5 billion dam project that now may never be finished.

Construction at the Yamba dam, five decades in the making, has been halted by Japan's new government, which wants to scrap dozens of public works projects it considers wasteful.

Yamba, the first to get the ax, has become a national symbol of the big-money projects favored by the old government led by the Liberal Democratic Party.

The LDP — which ruled the country for nearly all of the last 50 years but was recently ousted in national elections — pumped billions of dollars into rural areas for elaborate tunnels, bridges and dams, many of which get little use.

Prime Minister Yukio Hatoyama's rival Democrats promised during their campaign to end that legacy of public works spending. The party wants to free up funds for new polices like handouts to farmers and families with children.

Just hours after he was appointed last week, Land and Infrastructure Minister Seiji Maehara said construction on the dam would stop.

But the freeze of the Yamba has sparked an outcry from local residents who have become invested — emotionally and economically — in the project. Many have construction-related jobs, and they don't want the sacrifices they made for the reservoir the dam will create — giving up their land, moving family graves — to go to waste.

"I just want them to finish it. It's sad to still be here, you can tell people are hurting just by their faces," says Tsutomu Mizuide, a 16-year-old whose family runs a small restaurant in an area that will be submerged.

The Yamba dam, about 80 miles (130 kilometers) northwest of Tokyo, was first designed to help control flooding after a typhoon ravaged the mountainous area. In the years since, it has grown to include power generation and water provision for four different prefectures plus Tokyo.

When the project first got under way decades ago, local residents waged a spirited campaign to save the area, but as the fight dragged on, most people gave up in resignation, accepting cash payouts for their land or resettlement deals.

 

[Francesca R]

Has anyone ever shown this to be true, from a consumer standpoint?

No, never.

(BTW--Macroeconomics is not physical science, it is still less scientific than microeconomics, which itself is a field of social study. So you don't get laboratory proofs)

Deflation doesn't compare to the changing prices of technology due to new innovations.

That's displacement and obsolescence (and "Moore's law"). As you indicate it is entirely different from general price declines.

I assume Japan's CPI index like the US's includes a housing component, right? Couldn't the continued decline of real estate values account for the whole "deflation" they are seeing?

No, neither Japan's nor the US's CPI contains real estate values. The cost of housing services is captured with imputed rents, which do not vary anything like as much as house prices. There are various methods for calculating imputed rent. Source 1 Source 2

Correct me if I'm wrong but I'm almost certain major capital goods aren't factored into the CPI.

Correct, since it is an index of the prices of consumption goods. That's why house prices are not in there either.

In America we saw the CPI take a dive almost exclusively because housing prices collapsed.

As above, this is wrong. In any case the S&P-Case-Shiller home price index in the US peaked in July 2006 and was already falling by 10% y/y by January 2008. CPI inflation carried in increasing through July 2008.

You have to be very careful how you use the words deflation and inflation. There is no perfect method for measuring price inflation/deflation. You can have monetary inflation and price deflation at the same time. That seems to be happening now in the US. I'm just wondering if the situation in Japan is in some way similar.

Price inflation/deflation is what is being discussed here.

 

[Francesca R]

Doesn't seem to bother the currency markets yet. Is is because the currency markets are wrong?

Well leaving aside "debt monetisation/devalation" risk, the combination of persistent current account surpluses (which has made Japan the world's biggest net creditor nation), and persistently lower inflation of tradeable goods and services than elsewhere (which improves export competitiveness) is actually positive for a currency. Against that, highly indebted governments are only a big problem if people don't think they can pay their bills.

Should a loss of credit rating affect exchange rates?

I would say so, ultimately yes. Hence the Russian rouble collapsed in 1998, the Argentine peso came off its US dollar backed board in 2001, and Ecuador surrendered its currency entirely and "dollarised" recently. But it isn't linear. Downgrading Japan from AAA to AA is probably not significant in the scheme of things. Not all that many countries still have AAA long term ratings.

 

[Tippit]

That is sort-of what happens when the BOJ buys Japanese government bonds. But it is lending to the government not giving to them--the JGBs are not cancelled ("forgiven") and the government remains in the central bank's debt, with the result that the BOJ's balance sheet grows bigger. It may appear semantic, but the government would need to default on JGBs held by the BOJ for it to reduce the public debt, absent an increase in government revenue (which would be produced by tax receipts or selling public assets). And if it defaulted on those, you can be pretty sure that holders of all the other JGBs outstanding would change their minds about how valuable they are pretty fast.

If the BoJ is run like any other modern central bank, then it automatically remits all of the interest less the BoJ's operating expenses to the Japanese Treasury. Then presumably the Japanese government merely spends the money back into the economy. So aside from the bank's expenses, the transaction of debt monetization is a wash and merely a series of bookkeeping entries. This slight-of-hand is necessary both to pay the bank for its existence, and to convince taxpayers that the government is actually borrowing something of intrinsic value when it borrows from the central bank. In any event, it shouldn't be viewed as a deflationary action as long as the government spends the money back in to the economy. Of course, it has the side effect of increasing the scope and power of the government.

 

[Tippit]

I've never actually tried to find out and have assumed that this is not possible. Certainly a statement by a central bank that it was tearing up its government bond assets would be viewed by the market as a default, and would therefore do all sorts of damage. So it is not at all viable.

A default is when the borrower fails to meet the terms of a debt obligation. Since the central bank is the lender, if it forgave sovereign debt this couldn't be construed as a default, as the obligation was with the government. Since the monetization of debt is mostly a wash anyway, it would have no consequence other than to perhaps limit the ability of the central bank to tighten, since it would be limiting its supply of bonds to sell in the open market. Of course, they have many other tools to do virtually the same thing anyway.

In the limit, governments have to repudiate debt. If they borrow heavily abroad, or if their domestic (private) savings are very low, or if the economy is simply tanking, this is more likely and it happens. Some think it is "increasingly likely" in Japan. The government lost its AAA credit ratings from Moodys and S&P several years ago.


ETA--Barron's story needs subscription, sorry.

The outwright repudiation of sovereign debt is historically very rare, and with good reason. Why would a nation repudiate its debt and therefore destroy its credit rating, when it could simply debase its own currency and accomplish virtually the same thing in a more surreptitious manner? The repudiation of sovereign debt is almost akin to a declaration of war. Better to debauch the currency over a period of time than to openly provoke its creditors.

I would be very surprised if any modern nation did such a thing, especially Japan. Can you even provide any historical examples of this?

 

[Francesca R]

If the BoJ is run like any other modern central bank, then it automatically remits all of the interest less the BoJ's operating expenses to the Japanese Treasury.

No that would go into its reserves. The Bank pays a dividend to its shareholder--which is the government--which is capped at 5% of book value (which is pretty low, like JPY100m). The shareholder does not get to participate in management. The MOF or the Prime Minister appoints the governor, same as how it happens elsewhere.

Then presumably the Japanese government merely spends the money back into the economy.

I think that's wrong. Do you have a cite?