Japan has been in a deflationary or liquidity trap since 1994 or before. Fiscal stimulus has been alternated with fiscal tightness. When the economy appears to grow well for a brief period, the government has tended to raise fees or taxes setting off an immediate slowdown and a spurt in government spending. The alternate periods of more government spending and taxing have kept Japanese "men" fairly well employed and staved off a crisis.

The central bank raised interest rates to limit rising stock market prices in 1990. Stock prices fell rapidly from the beginning of 1990. The central bank made no policy adjustments as stock prices fell, the economy began to slow in growth, and commercial and home property prices began to fall. By the time the central bank began to lower interest rates, Japan was nearing recession and experiencing rapidly falling property prices. Still, the central bank acted slowly and the rate cuts had slight effect.

Given Japanese deflation there is every incentive for consumers to spend sluggishly, and so incentive for business to invest sparingly for the domestic market. What is apparently needed is monetary policy that aims at an inflation target. Fiscal policy is hampered by a constantly expanding deficit. The central bank however has done nothing other than keep nominal interest rates low. Japan's economy continues to grow at a pace slow enough to generate further deflation.

What a problem.

"Thus the hopes----that Japan was pulling out of its long depression appear to have been false."

Come on Brad, you're surely not so innocent and naive as to have believed all that optimistic stuff earlier this year on Japan. Things are going to get a lot worse before we see any daylight. For starters the drop in the dollar made the export lead 'boom' inevitably a six day wonder.

Still this blog does confirm the leading role of the FT as a source of economic info on Japan (a handy companion to the much more detailed analyses - for eg on the CRIC cycle, or on the degree to which JGBs will need to carry a compulsory 'made of rubber' warning - which you can find on Stevie Roach's Global Forum.

But don't miss the companion piece on the 22 August about the possibilities of a U turn from Koizumi on bank reform, or the little detail that surfaced last week that China is well on the way to overtaking the US as Japan's number one trading partner, and in the case of imports in the very near future, with a big chunk of Japan's imports from China being equipment and machinery.
So if you want to know where some of the deflation is coming from, well you don't have too far to look.

The real problem is to understand not that Japan is ill, which is obvious, but why it doesn't seem capable of recovering. The Krugman argument is fine on the mechanics of how you get into the mess, but I don't think we've got to the bottom yet of the story on why it continues.

Why is a constant puzzle. Is it that Japan is really a single party democracy? The Liberal Democrats have powerful construction and farm voting blocs, for example, that they amply reward for support. Is it that Japanese families live quite comfortably? Employment is reasonably high and wages are generous.

Deflation makes the Yen continually worth more and the Japanese are fine savers. The Yen has been strong for a decade allowing imports of oil at reasonable low prices.

Slow growth is not depression. Japan has grown, but slowly for a decade. Japan began the slow growth period from a most affluent base.

Puzzling, but the Japanese have not expressed significant discontent. Perhaps this is an answer.

This is somewhat tangential, but China has many of the same problems in its financial services sector: virtually insolvent banking conglomerations holding major volumes of off-book debt, under-performing loans tied to underperforming assets (that banks are unwilling to either revalue OR unload in a depressed market). Meanwhile, the state has been cautious in its use of expansionary monetary policy because of the already high levels of inflation.

All of which raises a question. While Chinese banks may be insolvent, they certainly aren't illiquid: new savings continue to fuel investments, while SOE reform is actually starting to curtail the moral hazard problem responsible for the crisis in the first place.

Admittedly, unless China manages to maintain rather spectacular growth (7%+) through 2010, even professional cheerleaders such as Zhu Rongji admit to disaster in the making, but this all makes me very curious why Japan's extraordinary high savings rate isn't a more important contributor to Japanese liquidity? Adam Posen claims that about one-thrd of Japanese household savings were flowing into commercial banks in the early 1990s. Surely things haven't changed that radically, and if they haven't, why isn't this having more of an effect...?

China has high levels of inflation? I wasn't aware of that. If that's so, the CIA is even more incompetent than I thought: it claims that inflation in China is around 0.4% in the world factbook.

Julian Elson

Thanks Julian - it actually looks as if I stand well corrected. I simply hadn't been aware the Central Bank (or Asian Financial Crisis...) had been so successful in throttling back inflation after the roaring excesses of the mid-1990s. Ouch.

That being said, just checking with the Asian Development Bank, it looks as if the CIA is also using lowballing data from 2000.

For what it's worth, I do know that inflation continues to be a powerful political grievance - particularly among the xiagang in the southern provinces. Looking at these actual numbers certainly makes it difficult to take their complaints at face value though....

Thanks again, and sorry for misleading/confusing anyone.

I keep wondering what I'm missing. Why do we assume the whole time that govt spending leads to big public debts. It does if you bond finance the spending, but not if you just print the money. So why's this such a hard problem to treat. Treat it the way the Japanese seem to want to treat it with increased govt spending - if that is your wont. Alternatively you can issue the population with coupons for spending which expire in a few months - so they have to spend. But don't borrow the money - print it - until you've hit some inflation target whereapon it would become irresponsible to print more. Why don't people return to this as the anchor of the discussion.

China has had DEFLATION now for 8 months. Hong Kong has been deflating since the Asian crisis of 1998.

Morgan Stanley covers China's macro environment quite well.

Directly inflating Japanese prices by printing Yen may be viable in theory, in practice it is beyond consideration for political and cultural reasons. There is no way that Japan is going to adopt to radical a method and appear so inept.

Remember, the Japanese do not think they have a crisis. Rather they feel there is a structural problem that time will surely solve. This is a democracy, though a single party dominates, and there is no mandate for more than quite moderate change.

There really is no comparison between China and Japan. Japan has economic resources on the order of America or Germany or France or England. Thinking of Japan as other than an economic power is of no help. Toyota and Sony are as Daimler-Chrysler and General Electric.

There will be no financial collapse in Japan. The country will continue to be an economic power. The problem is to quicken growth again, to bring demand to levels that allow for growth of 4%.

Japan is definitely an economic power, but so is China. In fact, in PPP terms, I think China's GDP is bigger than Japan's (second only to the U.S.). Of course, China isn't as developed as Japan, Germany, France, Britain, or the U.S., except for the east coast, but still... China can hardly help being an economic power when it has 1/5 of humanity as a workforce :^).

Julian

re anon's comments - this is what I always get - owlish comments about Japan's physche. My point is a simple point of policy. If its that easy to solve deflation - as I'm suggesting - why does everyone go on about it as a huge problem we should avoid at all costs. If the Japanese want to be silly about it well and good, but my point is really to ask the wise and good on this site, am I missing something. I'm not an expert on what's going through the mind of the Japanese. I'm just asking, why isn't printing money to restore non-negative inflation just standard operating procedure in the economics textbooks? When I ask 'why have the Japanese deficit financed their stimulus?' I'm really wondering why anyone ever would if they faced deflation. If they'd printed money to finance govt spending, wouldn't they now be in a similar position - but without the big debt overhang?

'Directly inflating Japanese prices by printing Yen may be viable in theory, in practice it is beyond consideration for political and cultural reasons. There is no way that Japan is going to adopt to radical a method and appear so inept.'

It's much better to suffer through another decade of anemic growth. Keeping up appearences is more important than money!

Yes - I do wish Japan would adopt sensible marco policies to cure the deflation and slow growth problems - No - I do not think that fiscal and monetary authorities are going to adopt sensible policies in Japan unless the Japanese people perceive a crisis and opt for dramatic change.

China is of immense economic importance, so too India, but it is a mistake to underestimate the financial and technological significance of "smallish" Japan for all of Asia.

Well I think the discussion seems to have gone off course a bit here. The problem is not to make a comparisons with China, but to notice that China has entered Japan's orbit in a very big way Per capita GDP is certainly low (although growing) but this per capita GDP multiplied by population gives a very different impact picture - especially for anyone who's ever reflected a little on gravity based theories of trade. China is certainly one contributory factor to Japan's deflation (anyone still in doubt follow Andy Xie's column).

There is another: Japan has at present the most rapidly ageing population on the planet (the batton here is soon to pass to Italy and then Spain, so watch out in Euroland) and has a culture which doesn't readily accept immigration. These ageing problems seem to dwarf Paul Krugman's rightly expressed preoccupations with the future American social security system.

The point is we really don't know what it is that ails Japan (because collectively we haven't done enough work on it, but I have a strong feeling the above two factors form an important part of the picture - and there's no quick fix round the corner here.

One last point I forgot for Nigel Hawthorne.

Printing money, apart from its negative effect on confidence, produces, as you note, inflation (in quantities that it is not possible to calculate with any reasonable precision if you do so in the volumes you suggest Japan needs (in fact what's known as monetary 'easing' - which in this case involves exchanging JGBs for real assetts in the central bank reserves- has been happening in hefty doses. It's just, like the equally hefty US rate cuts, that this policy atpresent it isn't working).

But the real problem with inflation is that it destroys savings, and a lot (a hell of a lot) of Japanese people are old. Apart from seeming unjust, it is also unlikely to be politically unpopular given the quantity of old people.

There is just one last point for Nigel Hawthorne which I forgot.

Printing money, apart from its negative effect on confidence, produces, as you note, inflation (in quantities that it is not possible to calculate with any reasonable precision if you do so in the volumes you suggest Japan needs (in fact what's known as monetary 'easing' - which in this case involves exchanging JGBs for real assetts in the central bank reserves- has been happening in hefty doses. It's just, like the equally hefty US rate cuts, that this policy atpresent it isn't working).

But the real problem with inflation is that it destroys savings, and a lot (a hell of a lot) of Japanese people are old. Apart from seeming unjust, it is also likely to be politically unpopular given the quantity of old people.

'But the real problem with inflation is that it destroys savings, and a lot (a hell of a lot) of Japanese people are old. Apart from seeming unjust, it is also likely to be politically unpopular given the quantity of old people.'

Will they not mind massive unemployment among their children?