Climbing up the down escalator: Inflation still out of Japan’s reach


Inflation is not about to return to Japan just yet. According to the Bank of Japan’s latest “Outlook for Economic Activity and Prices” released at the end of last month, the BOJ Policy Board members’ median forecast for consumer prices in fiscal year 2005 is a 0.1 percent decline over FY 2004. Their outlook for FY2006 is a miniscule increase of 0.3 percent. It may not be the cork-screwing down of prices that we grew accustomed to in recent years, but neither is it inflation as we have known it in the past.

In an inflationary world, everything moves in fast-forward mode. It is as though you are running up an upward-moving escalator. Prices rise, profits rise, incomes grow, spending increases, people grow richer, or so they think, they spend even more, their demand pulls prices up even further. . . . and so we keep racing ever more faster up the escalator, until we get to a point where there is no longer anywhere else to go but down.

And the way down tends to be not so much an escalator any more, but a very steep and very smooth slope with nothing to hold onto. The whole experience can be quite scary. But at least the process is relatively straightforward.

Not so when it comes to the world of deflation. This world is a very sticky one.

If inflation comes in fast forward mode, everything goes into slow motion once deflation sets in. It is like trying to go up a downward moving escalator. You expend an enormous amount of energy for such little progress. Companies can actually be quite busy in a deflationary world. Their products may actually sell quite well, as manufacturers of flat-screen television sets know only too well. Yet as they know equally well, booming sales do not necessarily mean booming profits in a deflationary environment. People may work longer hours to meet the explosion in demand. To that extent it may feel like old times. Yet the difference between now and then is that the price of the things you are so busily making just keeps going down and down.

It is a very tiring state of affairs when for every upward step you take, the ground shifts two paces back. Under less deflationary circumstances, all that demand flooding in from China would have gotten us off to a fine start by now. Yet because of the downward-moving escalator, even China’s seemingly insatiable appetite for our steel, heavy machinery, cars and other things hasn’t really gotten our internal combustion going in the way one would have expected.

Meanwhile, there is another kind of worry that may or may not be lurking on the horizon. That is the possible return of asset inflation, even as price deflation persists. With all the money that the BOJ has been pumping into the economy, the whole system is awash with liquidity. What if that liquidity were to find its way into the property market? This seems to be very much on the mind of that other central bank, the ECB. The ECB’s president, Jean-Claude Trichet, has repeatedly expressed his concern over this point regarding the euro area. For the moment, the problem does not seem to be on the BOJ’s radar screen. That is just as well. For if asset inflation starts to happen alongside continuing price deflation, that is like suddenly finding half of your body on the up escalator while the other half remains firmly glued to the downward one. The only result possible is for you to be torn apart. May heaven spare us that gory outcome.