Author: Gunther Schnabl, Leipzig University
Inflation rates have risen far above the targets of many central banks around the world, reaching 9.1 per cent in the United States and 8.6 per cent in the euro area in June 2022. Yet Japan has bucked this phenomenon by maintaining surprisingly low inflation rates, sitting at 2.4 per cent in June 2022.
For many years, Japan’s inflation rate has been well below other industrialised countries even though the Bank of Japan’s balance sheet has grown much faster than the balance sheets of most other central banks.
Inflation is generally caused by central banks printing too much money, but this has not been the case in Japan. Since the bursting of Japan’s bubble economy in December 1989, money supply has grown much faster than the quantity of goods and services — without a substantial increase in consumer prices. Japan’s low inflation conundrum can be explained by three factors.
The Bank of Japan’s increasingly expansionary monetary policy has gradually lowered the financing costs of corporations. This has helped them keep prices low. Extensive government bond purchases by the Bank of Japan enabled the Japanese government to subsidise goods and services on a large scale. Estimates indicate that about 50 per cent of goods and services in the Japanese consumer basket — used to measure consumer price inflation — are subsidised. Since 1990, Japanese government subsidies have roughly quadrupled, reaching 130 trillion yen (US$98 billion) in 2021.
The Bank of Japan’s expansionary policy has kept interest rates in Japan steadily below the United States. This has led to a continuous outflow of capital to the United States and other countries. Private households have invested parts of their savings in US dollars, life insurance companies have bought US government bonds and Japanese banks have extended loans to Southeast Asia. This outflow of purchasing power has reduced inflationary pressures for goods and services and in Japanese asset markets.
While government subsidies for corporations and persistent capital outflows have kept domestic inflation low, falling interest rates on bank deposits have increased the incentive to keep savings in cash or bank deposits. Since most Japanese people no longer distinguish between investing and saving, the money supply has been able to increase without inflation following suit. Low inflation has subdued demands for higher wages, particularly since the Japanese financial crisis in 1998.
US and European governments — facing greater political pressure due to soaring inflation — may consider emulating Japan’s low inflation policy. But they should keep in mind that huge central bank-financed government spending has crippled the Japanese economy and contributed to gradually falling inflation-adjusted wages since 1998. After three lost decades, including the 10 years of Abenomics, living standards in Japan continue to decline. This trend is shifting a tremendous burden of government debt onto younger generations.
Japanese Prime Minister Fumio Kishida’s ‘new capitalism’ is unlikely to change Japan’s declining living standards. Calls for more investment in human capital, greater support for innovation and start-ups as well as planned efforts to decarbonise and digitalise may provide the Japanese economy some short-term growth stimulus, but at the cost of even higher government debt.
They also fail to address the core problem — that the overhang of money from three decades of heavy subsidising has zombified Japanese corporations and prevented structural reform. Kishida’s strong focus on inequality will only encourage price controls through subsidies.
The announcement of decisive interest rate increases in the United States will put pressure on Kishida’s new capitalism. The US Federal Reserve has been forced to increase interest rates to combat inflation. Unlike Japan, this response was required from the US Federal Reserve because there are less subsidies to control prices, more buoyant capital inflows and wages are rapidly increasing in response to rising prices.
With rising interest rates in the United States likely to attract greater capital inflows from Japan, the Bank of Japan’s attempt to keep the interest rates of Japanese government bonds low may help keep the government budget sustainable. But the Japanese yen will depreciate further and rising prices for imported goods will drive up consumer prices faster. Kishida’s new capitalism may prove less robust than Abenomics.
Kishida could introduce capital controls to stop the Japanese yen depreciating, but this would accelerate the decline of welfare in Japan. The country should instead embark on comprehensive reforms, like those of the Meiji-era, such as the reconstitution of a hard currency to safeguard welfare in Japan.
Gunther Schnabl is Professor of Economic Policy and International Economics at Leipzig University.
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