The whole world could be the envy of Japan, at least when it comes to inflation. While many countries are troubled by rising prices and the level of inflation is hitting multi-year highs, one of the few countries is going against the tide. For the past 30 years, Japan has been dealing with deflation or its threat.
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In addition, while the world’s major central banks are raising interest rates in the fight against inflation and will probably continue to do so, the Bank of Japan has no reason to do so and has announced that it will continue to maintain its loose monetary policy. The Bank of Japan thus remains one of the last major central banks not to raise rates and not planning to.
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The basic interest rate thus continues to remain even in negative territory at the level of minus 0.1 percent. A negative interest rate is a measure intended to be a response to recession, slow economic growth, low investment and low inflation. It is supposed to stimulate banks to lend more to households and businesses, instead of holding deposits with the central bank, for which they have to pay it. For comparison, the basic interest rate of the Czech National Bank is 7 percent, even the “stubborn” European Central Bank increased the basic rate to 0.5 percent last week.
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Japan, on the other hand, has been struggling with low inflation and weak economic growth for a long time. Although Japanese inflation has remained above the central bank’s two percent target for the third month in a row, the Bank of Japan and many economists are convinced that the current wave of inflation will be temporary and will subside as soon as the impact of higher import prices is felt in the economy. Everywhere else in the world, however, the situation is the opposite – inflation in the Czech Republic for June is 17.2 percent, which is the highest since 1993. In June, price growth in the EU reached 9.6 percent, and in the USA, for example, 9.1 percent, which was the highest since 1981.
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Low inflation
According to Vít Hradil, Chief Economist of Cyrrus, the main reason for Japan’s low inflation is the sluggish performance of the local economy, which has practically not been able to show growth in the past thirty years.
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The labor productivity of the Japanese is increasing significantly more than their wages. So the Japanese labor market does not create an inflationary environment.
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“This era was started by the bursting of the real estate and stock bubble in the early 1990s, and Japan has not been able to get out of it yet. Among the main long-term factors dampening Japan’s economic boom are enormous indebtedness and unfavorable demographic developments, i.e. a dramatically aging population. Low inflation is thus more a symptom than the disease itself,” explains SZ Byznys Hradil.
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“However, it is a fact that such a long period without inflation also affects the way in which society subsequently deals with the extraordinary inflationary shock that the world is going through now. In Europe or the USA, price growth is still considered a common phenomenon, and when production costs rise dramatically – for example due to more expensive energy – prices of consumer goods will rise,” says Hradil.
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In other economies, employees try to protect themselves by demanding higher wages, and the entire economy thus shifts to a new, more expensive, equilibrium level. But in the land of the rising sun, the situation is different.
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Japanese inflation has been at low levels for a long time.
“In Japan, where price growth is no longer considered normal, companies prefer to try to save elsewhere, for example by lower wages, when costs increase. The result is similar in both cases – people in Europe and Japan will eventually be able to buy fewer goods with their wages,” adds Hradil.
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“Although Japan has a loose monetary and fiscal policy, high inflation avoids this country. One of the reasons is the fact that Japanese labor productivity increases significantly more than their wages. So the Japanese labor market does not create an inflationary environment, as we see it in the Czech Republic,” Štěpán Křeček, chief economist at BH Securities, told SZ Byznys.
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According to Křeček, the Japanese are very thrifty and create huge savings, so consumption is kept at a low level and is in balance with the supply on the market. This eliminates the inflationary pressure that was caused in the European Union and America by the disruption of supplier-customer relations and the resulting supply problems.
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“Although Japan has been hit by high fuel, natural gas and electricity prices, the increases there for these items are significantly lower than in the European Union, which, unlike Japan, suffers due to a significant dependence on commodity imports from Russia. In this respect, even the United States, which is energy self-sufficient, has an advantage over the European Union,” adds Křeček.
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Inefficient tools
The Bank of Japan pioneered the policy of quantitative easing, i.e. massive purchases of government bonds by the central bank. Originally, this policy had a target defined by the volume of bonds that would be purchased – hence the name “quantitative”, i.e. targeted at the “quantity” of bonds.
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Japan’s inflation immunity to the rest of the world is very high.
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“Japan subsequently moved this technique to a higher level under the pressure of circumstances and switched to the so-called yield curve targeting. Here, too, we are talking about purchases of government bonds by the central bank, but the goal is a specific level of returns. The Bank of Japan thus buys government bonds in such a volume that it keeps the ten-year government bond yield close to zero percent,” economist Hradil points to the instrument used by the central bank.
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“However, as can be seen from the state of the Japanese economy, these instruments did not lead to the desired goal, i.e. stimulating demand and economic activity in general. In addition, they are currently causing strong pressure to weaken the Japanese currency, while the favorable effect on exports is weakening, and on the contrary further worsening Japan’s import position,” says Hradil.
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Overall, after many years of operating this experimental policy, its effect cannot be assessed as a great success, according to the economist, but according to him, it is difficult to estimate whether Japan would be even worse off without it.
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A short-term fluctuation
The Bank of Japan has been struggling with very low inflation for a long time, which it is trying to pull towards its target. Although June inflation, which rose to 2.4 percent, is above the central bank’s two percent inflation target for the third month already, according to economists, it is more likely just a short-term fluctuation influenced by world food and energy prices.
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“Medium-term inflation developments, which are key to setting monetary policy, are still muted, and it can be expected that Japanese inflation will quickly return to below target following the expected halt in the growth of global inflationary pressures. Therefore, the Bank of Japan keeps its monetary policy relaxed and does not rule out further downward movement of interest rates,” estimates Jiří Polanský, an analyst at Česká spořitelna, in a comment for SZ Byznys.
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According to Peter Dufek, Chief Economist of Creditas Bank, due to low inflation, the Japanese central bank can afford to maintain low interest rates and, in the interests of financial market stability, take unconventional measures to support the economy.
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“Japan’s inflation immunity to the rest of the world is very high. We may only see an increase in food prices, but even that is not dramatic,” says Dufek.
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Weak currency
The Japanese yen has been weakening almost continuously since the end of 2020, and in recent weeks has even fallen the most in 25 years against the dollar. In addition to the weakening of the Japanese currency, the strengthening dollar also weakens the monetary policy of the Bank of Japan. The weak Japanese currency is now helping Japanese exporters and thus the entire economy on the one hand, and on the other hand it is increasing inflation through higher import prices.
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“Given medium-term low inflationary pressures, the Bank of Japan would need an even weaker yen, although in the recent past, its officials have talked about the possibility of countering the yen’s rapid weakening through verbal intervention. However, direct foreign exchange interventions would probably not be very popular with the US representatives, which may be the reason why the Bank of Japan may not want to get involved,” believes analyst Skořepa.
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Creditas’ Dufek believes that given the low inflation and expansionary monetary policy, the central bank will leave the Japanese currency free.
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“Why not, when a weaker currency doesn’t harm them in any way and it also helps exports. It is also beneficial given that the Bank of Japan focuses on inflation and interest rate curve management. Managing the exchange rate in such a situation would be difficult and expensive,” the economist rules out possible interventions on the foreign exchange market to strengthen the Japanese currency.
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