Sun, Jul 17, 2022 page9

• Japan’s low inflation is tied to its loose monetary policy

  In contrast to many countries since the pandemic started to ease, monetary velocity, or the rate at which money changes hands, has slowed in Japan

  • By Richard Cookson / Bloomberg Opinion
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  For people like me who think inflation in much of the developed world is likely to remain uncomfortably high and persistent, Japan poses a problem.

  If you ask most economists or investors why inflation has surged, they would probably offer two main causes: first, the sharp rise in commodity prices, especially energy, and second, the massive expansion of central bank balance sheets. The snag is that Japan has had more of both than most developed countries.

  The Bank of Japan’s (BOJ) balance sheet is more than twice the size of the European Central Bank’s as a proportion of GDP. A rapidly weakening yen (partly the result of this monetary laxity) has driven up import prices dramatically. In May, import prices rose 43 percent compared with a year earlier. Japan imports almost all its energy, and oil has risen about 93 percent in yen terms.

  

  llustration: June hsu

  Yet, you would be hard-pressed to describe domestic inflation as anything other than quiescent. Consumer prices in May rose just 2.5 percent from a year earlier. Although rising, the numbers are nothing like the US, the eurozone and the UK — nor Japan’s own experience in the early 1970s, when inflation was almost 25 percent.

  Most people ignore what is going on in Japan, but how can you be certain about what is happening elsewhere unless you can explain why it is not happening in an awkward counterexample? Japan is not alone. Inflation in Taiwan and China, to take but two examples, is also relatively low.

  I would be lying if I said that I have a complete explanation for the lack of inflationary oomph in Japan, but the following are my best attempts:

  First, paradoxically, it is monetary policy. Policy rates have been minus-0.1 percent for the past six years and have not been above 0.5 percent since 1995.

  In 2013, the BOJ started buying long-term government debt and in 2016 followed that up with yield curve control, buying as many bonds as necessary to keep yields from rising above its target rate, which is currently about 0.25 percent.

  AGING POPULATION

  Very low interest rates are meant to tempt households and companies to spend rather than save, but when a population is aging rapidly, as is Japan’s, the evidence suggests they save more to make up for derisory returns. That is why the household savings rate has gone up, not down.

  Moreover, Japanese companies have been persistent savers for many years, meaning they have invested far less than they earned. So not only have very low rates not encouraged the private sector to spend more and save less, they seem to have had precisely the opposite effect. By the equal and opposite token, higher rates might well be more stimulatory — and inflationary.

  However, what super-loose monetary policy has done is keep many companies in business, particularly domestic ones, that should have gone under, and, for 10 years or so, Japan’s population has not just been aging, but shrinking, meaning less demand for a given level of supply. That was almost bound to be disinflationary.

  Elsewhere in the world, even in countries with aging populations, government responses to the COVID-19 pandemic shifted the balance of demand and supply. By shutting down their economies, governments in effect built up demand and reduced supply. This had the effect of jolting prices higher when economies reopened. The Japanese government did not shut down the economy, so there was much less of an uptick in prices as it reopened (although there was clearly a knock-on effect from other countries). Higher energy prices have been reflected far more in shrinking corporate margins than in higher prices.

  This lack of a jolt in prices, I suspect, has been crucial.

  Monetarists find Japan hard to explain. On a simple explanation, increases in the stock of money should ultimately lead to inflation.

  US-EU CONTRAST

  In the past few years, the growth of money, broadly defined, has not been anything like as dramatic in Japan as in, say, the eurozone or the US.

  However, growth has been going on for far longer, so the stock is much higher relative to its GDP than other developed countries.

  Inflation has not gone up because, as was the case elsewhere in the world before the past couple of years, the velocity of that money — how fast it changes hands, in effect — slowed.

  In many big economies, this velocity appears to have recently accelerated in large part because sharply higher prices encourage consumers to spend now on goods and services before prices rise even further. At a certain threshold, I suspect, greater velocity is a result of higher inflation, not its cause.

  Therefore, Stephen King, a senior economic advisor to HSBC Holdings, estimated that the cause is the industrial strife that plagued many countries in the 1970s — Japan included.

  Of course, labor strife in Japan looks as likely now as the current harmony would have done in the 1970s, but as has been spectacularly evident in the UK in the past few months, labor in general has become a lot more uncooperative as a result of rising prices.

  They were not the cause of their going up in the first place, King said.

  Clearly, a shrinking population and, paradoxically, monetary policy that has been in place for far longer than most traders have been alive — even though it has manifestly failed — have made it harder for an inflationary spark to take hold in Japan.

  However, that does not mean it cannot. Crucially, it does not mean inflation in other countries cannot continue to be a problem.

  Richard Cookson was head of research and a fund manager at Rubicon Fund Management. Previously, he was chief investment officer at Citi Private Bank and head of asset allocation research at HSBC. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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