Many misconceptions and faulty narratives about Japan’s economic trajectory after the burst of its bubble economy exist. The one most confusing is Japan’s Deflation.
Pundits twisting
the deflation story as if Japan suffered a deflationary death spiral, are obviously
getting it all wrong. But also the fraction claiming that Japan’s deflation,
although prolonged, was very mild err. Busting this myth is a little tricky,
because taking Japan’s CPI numbers at face value the statement is correct.
According
to official CPI numbers Japan first witnessed deflation around the year 1999/ 2000.
Since than inflation/ deflation has been oscillating around +/ - 2%. Average inflation
since 1990 has been around 0,4 %. Nothing to write home about.
The only trouble with those numbers is they are misleading. Up until beginning of this year the Japanese methodology measuring inflation had been heavily biased upwards when compared to western methodologies, significantly understating deflation. European and Anglo- Saxon statistic bureaus have been constantly modifying their methodology measuring the index. The Japanese not so much.
Two of the
most relevant measurement differences in the Japanese CPI were:
1.) “Fixed
weighting patterns”. Not addressing consumer’s substitution bias when relative
prices for same/ similar products are changing
2.) The
limited use of hedonic pricing models, i.e. neglecting quality improvement when
computing the CPI
For instance,
only in the year 2000 did Japan adopt hedonics for computers, and for digital
cameras in 2003. And till late 1999 Japanese CPI included phonographs, but not CD
players. Assuming that prices of CD players had fallen faster than those of
phonographs would lead to an upward bias.
It is
guesstimated that if Japan calculated its CPI like the U.S did, deflation would
have been 1-2 % p.a. higher! Given the prolonged period of time (at least two
decades) the phenomenon had been in existence the measurement difference
compounded hugely.
The implications
for Japan had been manifold and significant. On the fiscal side the government overspent
on government transfers that are indexed to the CPI, like public pensions and social
security transfers. Overspending on debt service had been limited as indexing
JGB’s for inflation is rare.
On the monetary
front the underreporting was even more disastrous. The BOJ’s policy was way too
restrictive given the “true” state of deflation. The central bank committed
several policy errors, like the premature tightening in 2006 following the QE
experiment introduced in 2000. Formal inflation target, even under Kurodanomics,
were frequently missed by a much wider margin than officially admitted. The
decade long Japanese ZIRP policy turns into a cynical farce, as real interest
rates were in line with those of other major economies.
Discrepancies
are so significant that it renders a cross-country comparison of (real)
macroeconomic variables like real GDP growth or purchasing power parity almost
useless and only leads to wrong conclusions about Japan’s (real) economic
performance during the “lost decades”.
Most importantly though, the underreporting of deflation has a huge impact on the real value of the yen. Already official numbers indicate a severely undervalued currency. Actually, the Yen is trading against the US Dollar CPI adjusted at levels last seen before the Plaza Accord of 1985. Also, the official real effective exchange rate (REER) against a basket of currencies is indicating a value normally seen at emerging market currencies.
Taking into account the
significant and prolonged underreporting of the Japanese CPI pushes the (real)
REER of the Yen to levels where even Recep Tayyip Erdoğan would be bursting
with envy. In short: Japan is dirt cheap!
Source:
Deflation in Japan: Worse than you think | VOX, CEPR Policy Portal (voxeu.org)
BIS Statistics Explorer: Table I2
Here's
why the yen is at a 36-year low versus the U.S. dollar, by one measure -
MarketWatch
Defining Price Stability in Japan: A View from America (nber.org)
https://www.boj.or.jp/en/research/brp/ron_2020/ron201030a.htm/
Lessons
from Japan: coping with low rates and inflation after the pandemic |
Financial Times
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