What is the first thing that comes to your mind when you hear “JAPAN”? Maybe you’re a gamer and you thought about Sony’s play station or is it you’re hungry and thought about sushi or did you think about a Samurai or a weird Japanese TV show?
I can tell you, economists think about deflation. And there is a good reason for that!
Japan has been in deflation for the past 20 years!
– Inefficient monetary policy
– Financial shocks from Asian crisis in the 1990s, tech bubble of 2000 and 2008 financial crisis
– Decrease in prices after the Japanese real estate bubble burst at the end of the 80’s
– Inflow of inexpensive goods from other Asian countries. To stay competitive Japanese businesses had to decrease their prices.
In a deflationary society, individual businesses cannot raise their prices. If they did their sales would suffer, as they wouldn’t be competitive anymore. Not being able to raise prices means profits will stall. And thus forecasting limited long-term profits, businesses will decrease their investments and keep hiring at a minimum.
In the same manner, households expecting no increase in wages and decreasing prices in the future, will decrease their consumption until prices are lower and lower. Thus limiting growth.
And that is what happened in Japan. Instead of investing, Japanese households and businesses saved their savings for future consumption. Furthermore, it is important to remember that household savings are banks’ liabilities. So banks not being able to lend and increase their assets, started buying safe Japanese government bonds. Meanwhile, a decrease in tax revenues and a growing spending that is needed to support an aging population, increased government debt substantially. In 2013, Japan government debt was 10 Trillion Yen with a GDP of 6 Trillion.
The whole economy was in a vicious cycle. Prices did not increase, sales and profits declined, wages stalled, consumers stopped spending, and prices continued to decrease.
This long-term deflationary trend had a psychological impact on the Japanese society. They got used to saving and investing in safe assets only. However for the country to get out of this deflationary spiral, Japanese people will need to spend and invest in riskier assets.
And that is why the Japanese central bank initiated a QE programs. By buying JGB, the government puts pressure on long-term nominal interest rates.
The goal is to keep interest rates low to stimulate spending. Which should increase inflation. But remember, it needs to be slow and stable inflation otherwise it would be devastating for the country.
If all goes according to plan everyone can live happily ever after. If not, inflation will eat savings, devalue the currency and send the stock and bond markets to perdition.