The Nikkei stock index, a beacon of Japan's economic health, recently reached a 34-year high, sparking a surge of optimism. This momentous event coincides with mounting evidence of Japan seemingly breaking free from the shackles of deflation, a prolonged period of falling prices. However, the narrative of a complete victory against deflation may be overly simplistic.
While some see low, positive inflation as a harbinger of economic prosperity, others remain skeptical. Consumers often find the notion of "bad deflation" counterintuitive, especially after witnessing the recent price surges in economies like the US. However, the danger lies in persistent price declines, year after year, as wages, incomes, and asset values tend to follow suit. This creates a domino effect, with debtors struggling to repay loans, businesses hesitant to invest, and the financial system at risk.
The scars of the US Great Depression, where prices plummeted by 27% from 1929 to 1933, serve as a stark reminder of deflation's destructive potential. Even mild deflation can hinder growth by making borrowing less attractive. Central banks, in response, typically employ low interest rates to stimulate spending. However, such measures become ineffective when inflation itself is negative, creating a conundrum.
Japan's battle with deflation began in the early 1990s after the bursting of its asset bubbles. The ensuing losses crippled banks, further hindering lending and pushing inflation into negative territory in 1999. Western economists, including future Federal Reserve Chair Ben Bernanke, urged decisive action to combat this economic malaise. The Bank of Japan (BOJ) responded, initially hesitantly, then wholeheartedly, employing a range of unconventional measures, including zero and negative interest rates, massive government bond purchases, and even stock market intervention.
Despite these herculean efforts, achieving consistent inflation remained elusive. It wasn't until the global supply chain disruptions of the pandemic that underlying inflation finally reached the BOJ's target of 2%. However, the question remains: was deflation truly the root cause of Japan's sluggish growth over the past 25 years?
The answer is not clear-cut. Some argue that deflation was more of a symptom than a cause. Japan's working-age population started declining in the early 1990s, coinciding with the end of its post-war economic boom. Additionally, industries began relocating production to cheaper locations, exerting further downward pressure on prices, wages, and growth.
Interestingly, when adjusted for its shrinking population, Japan's performance appears less dismal. From 1991 to 2019, its output per hour worked grew at a respectable 1.3% annually, comparable to major economies like Canada and France. This highlights the importance of considering context when evaluating economic performance.
While the recent Nikkei rally and modest inflation indicate positive developments, challenges remain. Wage growth hasn't kept pace with inflation, and the economy entered a technical recession in the latter half of 2023. The "peace dividend" of conquering deflation, for ordinary Japanese, seems elusive.
Japan's journey out of deflation has been arduous, filled with experimentation and uncertainty. While the full impact of recent developments remains to be seen, one thing is clear: pronouncing a definitive victory is premature. Moving forward, Japan needs to address structural issues, such as workforce shortages and wage stagnation, to ensure sustainable growth and prosperity for all its citizens. As the nation navigates this uncharted territory, the world will be watching with keen interest, eager to learn from its unique experience.
