Japan Deflation Issue

Contents

Introduction

I. Current overview of Japanese Economy

II. Japan's Deflation since the 1990s

III. Why Is Deflation a Problem?

IV. Japan's General Price Deflation since the 1990s and the Debt Burden of Borrowers

V. The Negative Financial Accelerator in Japan since the 1990s

VI. Policies to Deal with the Problems

References

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Introduction

There is much confusion in popular discussion of Japan's deflation and associated economic problems. This confusion tends to arise from a failure to distinguish between three related, but different phenomena: the stagnation of the real side of the economy, the deflation of general prices, and the deflation of asset prices. The deflation of general prices has certainly persisted since the mid- or late 1990s, depending on the price index one looks at. However, the extent of the price decline has been mild. The cumulative decline in the consumer price index (CPI) since its peak in 1998 has been no more than about 3%. It is hard to believe that such mild declines in general prices have been the root cause of the stagnation of the economy.

Declines in asset prices since the 1990s in Japan have been as large as they were during the Great Depression. Both TOPIX and the price index of urban commercial land have plummeted by 70-80% from their peaks. The collapse in asset prices has had serious effects on Japan's financial system, and in turn, on the economy, including general prices. In this short paper I attempt to discuss the relationship between such deflationary forces.

In section one, We first discuss the general view of current Japan’s economy so, we can make out some tangible results. Moreover this Deflation issue and general view can be associated easier by using these informations. In secion two, we discuss salient features of the recent deflation in Japan. This section contains a quick survey of analyses of the causes of the recent deflation of general prices. In section three, We briefly summarize the behavior of the price level, and of nominal and real interest rates during the Great Depression. We also refer to the literature on the causes of the Depression, paying particular attention to the so-called debt deflation theory and the role of the negative financial accelerator. The discussion in this section provides a benchmark against which to evaluate Japan's deflation experience since the 1990s. This is done in section four, where we basically show that Japan in recent years has not seen as serious a debt deflation as that experienced in either Japan or the U.S. during the Great Depression. There is no evidence of a sharp rise in real interest rates and thus in the real debt burden as a result of the deflation in general prices. It is also clear, however, that any significant rise hereafter in the rate of general price deflation substantially raises the risk of throwing the economy into a deflationary spiral.

As stated above, it has been the deflation of asset prices, not that of general prices, that has generated serious negative effects on the balance sheets of borrowers and, over time, on those of lenders. Through this route a negative financial accelerator has set in, adding to deflationary forces in the economy. This process is described in section five. Finally, in section six, We turn to the discussion of the appropriate policy response to deflation. Debt deflation caused by deflation in the general price level can be cured by macroeconomic policy to stop deflation, and measures to address problems in financial intermediation. Japan's recent case is, however, a difficult one as the deflation of general prices has not been the root cause of these problems. Moreover, asset price deflation was a natural market response to the bubble of the late 1980s. In addition, there is some evidence that the return on capital has been on a secular declining trend since sometime in the 1980s, giving support to the view that "reforms" are a key to sustained recovery. Worse still, the failure to address financial system instabilities at an early stage has substantially reduced the effectiveness of macroeconomic policy in easing even general price deflation. Such a complicated chain of events has not been well understood and has led to confusion in popular discussion on "deflation." Anyway, one thing seems clear, namely, the need to address the financial