For the first time in eight years, Japan’s consumer prices (excluding those of perishable food) are forecast to rise on an annual basis, albeit only slightly. A 0.1 percent increase in consumer prices is expected for the fiscal year starting April 1, 2005, according to an economic and price outlook released in late October by the Bank of Japan.
Since a number of BOJ Policy Board members are predicting a continued price decline, the report stops short of saying deflation will disappear next fiscal year. Nevertheless, the message is promising: At long last, the protracted slump in prices appears to be nearing an end.
The on-and-off recessions that followed the collapse of the asset-price bubble in 1990 spread a mood of pessimism nationwide over the possibility that a combination of negative economic growth, stock market crashes and falling prices would trigger a deflationary spiral and send the economy into a tailspin. Some politicians and economists “talked up” that worst-case scenario, thus unnecessarily fanning a sense of an impending crisis among the public.
The BOJ came under intense pressure to take untested and risky steps to combat deflation, such as mounting a massive stock-buying operation and setting an artificial inflation target. It is good that those demands were rejected, for the much-ballyhooed threat of a deflationary implosion never materialized.
Now that the economy is undergoing an impressive recovery and the consumer price index (CPI) appears headed for an upturn, a public postmortem by those who had spread gloom and doom seems in order. In the meantime, private businesses have been trying hard to cut costs while promoting research and development projects. Those survival efforts, aided by sustained economic growth in the United States and the rapid expansion of the Chinese economy, are bearing fruit.
Now an era of inflation — the reverse of deflation — looms over the horizon. For now, though, the CPI remains negative, though only slightly, primarily because the economy has not yet completely recovered from the aftereffects of the bubble’s heyday. Major banks and businesses that overextended themselves during the unprecedented boom, to say nothing of small businesses, continue to suffer the consequences one way or another. But it is also true that consumers have benefited significantly from price falls driven by the massive influx of cheap products from China and Southeast Asia.
The point to remember is that bubble-induced deflation is bad, while imports-related deflation is not. It is wrong, therefore, to blame deflation in all its aspects. In principle, low-price imports provide a welcome catalyst for price stability and steady growth at home. The BOJ maintains an extraordinary policy of expanding the monetary base at zero-interest rates, as it is determined to get rid of deflation and spur private banks to dispose of their bad debts.
Since the debt problem with major lenders is being resolved for all practical purposes, the question of when to lift the zero-rate policy depends chiefly on progress on the deflation front. The central bank lists three conditions for a policy reversal: First, the CPI follows a positive trend year on year. Second, most Policy Board members expect such a trend to continue in the foreseeable future. And third, their forecast is supported by a general analysis of the economic and price situation.
The BOJ report, however, is noncommittal on the timing of a policy change. “It is unclear,” it says, “whether the time to change the framework of monetary policy will come in fiscal 2005.” The message to the market is: The zero-interest-rate policy will continue until the three conditions are met.
The BOJ seems optimistic about its future conduct of monetary policy. “During a process of stabilized and sustained economic growth, improved (corporate) productivity provides a basic antidote to price rises,” the report says. “(This) makes it possible to make flexible responses.”
The possibility remains, though, that rising prices will feed inflationary expectations. On this score, the report is reassuring: Inflation is nothing to worry about for the time being because productivity gains and cheap imports continue to hold prices down. Even if inflation sets in, it can be brought under control.
The trouble is that if inflation quickens its pace, taming it will become much more difficult. In a way, the history of central banks is one of fighting inflation. That’s why they are all committed to price stability. The Bank of Japan is no exception. Perhaps it is time to start drawing up a comprehensive anti-inflation strategy. Looming over the horizon is a new challenge for BOJ Gov. Toshihiko Fukui that could well prove to be even more daunting than fighting deflation.
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