Index > Briefing
Wednesday, April 28, 2021
Japan's Economy under the Threat of Deflation

It is within expectation that the Bank of Japan (BOJ) has decided to maintain negative interest rates and easing policies at the recently concluded monetary policy meeting. However, the Bank of Japan has made adjustments for inflation and economic growth as well as raising its economic growth forecast for the new fiscal year from 3.9% to 4%. The economic growth rate is expected to be 2.4% in 2022, 0.6 percentage points higher than previously. At the same time, it is also expected that Japan's core CPI for the 2021 fiscal year (April 2021 to March 2022) will increase by 0.5% from the previous forecast and lower to an increase of 0.1%. With the hope that the COVID-19 pandemic would be brought under control, Japan has raised its economic growth expectations, but the adjustment of inflation expectations is even more worrying. With low inflation, how can Japan achieve economic growth? Will it fall back into the trap of deflation? Under the impact of another wave of the pandemic, the situation that the Japanese economy is facing is far less optimistic than what has been estimated previously.

With the expectation of rising global inflation levels growing ever stronger, the downward adjustment of Japan's inflation seems to be out of place. While this is mainly attributable to the new wave of the pandemic, another cause for concern would be Japan's long term structural issues. As a matter of fact, in March of 2021, Japan's Consumer Price Index (CPI) fell by 0.2% year-on-year (the previous value fell by 0.4%); the core CPI, excluding fresh food, fell by 0.1% year-on-year, which has been a decline for eight consecutive months. As a result, some are worried that deflation is a growing threat looming over Japan.

The current monetary policy of the BOJ continues the original Abenomics approach, which aims to maintain yield curve control, reduce short-term interest rates to -0.1%, while the long-term interest rates (10-year Treasury bond interest rates) remain unchanged at around 0%. The BOJ has also continued to purchase exchange-traded funds (ETF) and maintain the 12 trillion-yen ceiling for asset purchases. This policy, which has been implemented for many years, currently provides a large amount of liquidity for the Japanese capital market, pushing up the Japanese stock market and bringing it back to the level when the Japanese economic bubble burst in the 1990s. This may be a rare achievement so far and this policy has brought the Japanese government's holdings of assets and proportions increasingly higher, becoming the largest "bookmaker" in the Japanese market which caused an artificial distortion, forcing the BOJ to make adjustments in the month of March. On the one hand, asset purchases have become more flexible; while on the other, it will continue to conduct "buy low and sell high" operations in order to increase market vitality. This policy of maintaining low or even negative interest rates has had little effect on inflation.

The battle that the BOJ wages against inflation has been ongoing for 8 years, but the stimulus effect that it has had on the economy and inflation is not exactly satisfactory, hence its approach has been increasingly suspected and criticized. Although the bank's governor Haruhiko Kuroda stated that he still believes by insisting on implementing the ultra-loose monetary policy, the 2% inflation target can be achieved. However, with the spread of the pandemic within Japan and the difficulty of boosting consumption, achieving the inflation target would prove to be a major challenge. Under the new wave of the coronavirus outbreak and a new round of lockdown, some economists have warned that these measures may trigger a double-dip recession. The results of an economic assessment survey conducted by the Japan Center for Economic Research (JCER) earlier this month showed that the economy is expected to still shrink in the first quarter of this year and rebound only in the second quarter.

In addition to the uncertainty caused by the pandemic and the lockdown, the long-term structural problems faced by the Japanese economy are believed to be the root cause of its difficulty in getting rid of deflation and low growth. While Japan's increasingly serious problem of aging population has not only made it difficult to increase consumer demand, it has also exacerbated labor shortages and restricted economic growth. At the same time, the Japanese government's monetary policy did not bring about adjustments in industrial policies to promote technological innovation, but it rather ushered in a "false prosperity" in the capital market. Some scholars are of the opinion that the Japanese government mistakenly believes that increasing public investment and lowering interest rates can promote economic development, resulting in no new industries being cultivated. This makes Japan appear to be outmoded compares to the process of rapid development in the digital economy of various other countries.

Under such circumstances, a proper action that Japan should consider is to further increase its investment in education, training and scientific research in fiscal and industrial policies to enhance its labor productivity. In addition, the space created by RCEP can be utilized to increase overseas demand. Moreover, what should be prioritized by Japan is to introduce external labor to improve its aging population structure. As it would be difficult to change the Japanese economy through years of monetary policy, Japan may require a structural reform to reverse the trend of low growth and overcome the risk of deflation.

Final analysis conclusion:

The Japanese economy, stimulated by years of loose monetary policy, still faces difficulty in ridding itself of the looming deflation. This is especially true with the uncertainty brought about by the COVID-19 pandemic, resulting in economic growth prospects which are not exactly optimistic. The Japanese economy needs a fiscal policy that focuses on long-term structural reforms before it can even hope to resolve the dilemma of low growth and inflation that it has experienced for many years.

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