Potential deflationary risks in Japan and what are the likely impacts?

Thomson Reuters News reported on March 24, 2014 that Bank of Japan’s (BOJ) Deputy Governor, Mr. Kikuo Iwata has recently voiced out the central bank’s concerns on the overall inflationary outlooks in Japan, where for the month of February 2014, core inflation, excluding food and energy, stood unchanged at 1.3 percent. The BOJ has set an inflation target of 2.0 percent to be achieved by the second half of 2015, and many critics have been voicing out their concerns over the seemingly unachievable inflation target given that Japan has been experiencing deflationary conditions for many decades due to the high growth rate of household savings, a fast growing greying population, the amount of spending made by businesses and individuals are not as robust as compared to developed nations such as the United States where nearly two-thirds of economy is comprised of consumer spending. Japan, on the other hand, has been focusing itself mainly on developing its manufacturing and exports sectors where investment spending is done on a long-term basis, and largely depends on the conditions of its key exports markets, currency and domestic regulations.

Mr. Iwata was quoted as saying that BOJ needed to set an inflation target of 2.0 percent in order to root out any expectations of Japan heading towards a deflationary cycle like the one seen during the 1990s. He believes that by setting a timeframe during the second half of 2015, the BOJ’s inflation goal will be seen as credible and measurable in the eyes of the investors. He went on to say that the 2.0 percent inflation target to be reached by the second half of 2015 is not a fixed target, but an expectation that the BOJ is showing the overall commitment that its monetary goals of kick-starting the economy are on track, monthly purchases on Japanese Government Bonds (JGBs), and mortgage-backed securities (MBS) are also being used in co-ordination with the intent of ensuring that rates are kept low in order to encourage spending by businesses, and consumers, thus generating the needed inflation needed to keep the economy running.

He was also concerned that if the BOJ were to set an inflation target of below the 2.0 percent, many Japanese households and businesses will no longer have any incentives to spend given that wages remained stagnant, and business conditions do not warrant any forms of capital expenditures made by businesses. This could worsen the overall deflation conditions seen in the past. By setting an inflation target of 2.0 percent, it is expected that it will lead to eventual spending. However, there are questions over how far can the BOJ do in order to encourage spending, as those motivations are not there, unless fiscal policies come into play that will create the business conditions that might probably encourage innovation, developing the core strengths in manufacturing, and perhaps could create favourable conditions for spending.

These remarks coming off from the Deputy Governor of BOJ are directed at sceptics who might have doubts over the 2.0 percent inflation target range. The impacts of the upcoming consumption tax hikes to 8.0 percent from the current 5.0 percent is seen as a crucial test for the BOJ in order to determine whether spending is expected to be robust, or turned sluggish following the unexpected rise in the retail sales numbers seen during the month of February. Was the increase driven by many businesses and consumers seeking to spend in advance of the tax hikes, and will it sustain beyond April? If spending levels were seen as what many investors have been anticipated of slowdowns following the April consumption tax hikes, how will the BOJ policy makers decide on the overall direction of the monetary policy stimulus measures? Will ‘throwing’ money to a far-off policy goal be worth the time, effort, and costs as measured by the cost-benefit analysis? These are questions that remained unanswered as to how the 2.0 percent inflation target can be achieved by the second half of 2015 following the upcoming hikes in the consumption taxes to 8.0 percent. There is a need to examine the potential fallouts of the consumption tax hikes, and the potential implications it might have on the spending mentalities, and motivations by Japanese businesses, and consumers. The risks of a slowdown in spending levels, coupled with the inability on the part of BOJ to generate inflationary conditions through its use of monetary policy tools might set Japan back to the past. These risks have to be taken into account in order to justify the worth of the monetary policy actions undertaken by the BOJ to ensure that Japan remains on a sustainable economic growth path.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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