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Japan’s “curious” lack of inflation

Summary:
Commenter Cove77 directed me to an article in The Economist, discussing the “curious” lack of inflation in Japan: Entrenched expectations built up through decades of little to no inflation play a big role in explaining why rising producer costs have not fed through to consumer prices. Domestic companies are notoriously unwilling to pass on increases in the prices of imports to consumers. At a press conference in October Kuroda Haruhiko, the governor of the Bank of Japan, attributed this reluctance to habits picked up during the country’s periodic bouts of deflation. Companies have a good reason to resist increases. Last week Kikkoman, a producer of soy sauce, announced a 4-10% increase in its prices from February. Such an event might barely be noticed in

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Commenter Cove77 directed me to an article in The Economist, discussing the “curious” lack of inflation in Japan:

Entrenched expectations built up through decades of little to no inflation play a big role in explaining why rising producer costs have not fed through to consumer prices. Domestic companies are notoriously unwilling to pass on increases in the prices of imports to consumers. At a press conference in October Kuroda Haruhiko, the governor of the Bank of Japan, attributed this reluctance to habits picked up during the country’s periodic bouts of deflation. Companies have a good reason to resist increases. Last week Kikkoman, a producer of soy sauce, announced a 4-10% increase in its prices from February. Such an event might barely be noticed in America. But in Japan it made the national news.

Another crucial factor is the weakness of Japan’s consumer recovery. Private spending fell in the third quarter of the year, and is now 3.5% below where it was at the end of 2019. Spending on durable goods, the source of much American inflation, has been practically flat for the past eight years in Japan.

The second paragraph is correct; a lack of consumer spending is the cause of Japan’s low inflation. (I prefer to focus on NGDP, but the two aggregates tend to move together.)

Given the lack of NGDP growth in Japan, low inflation is inevitable. The supposed “reluctance” of firms to raise prices (mentioned in the first paragraph) plays no role on the low Japanese inflation. To claim it does is to confuse causes and symptoms.  (Conversely, in America you see people complain about “price gouging” by oil companies, an equally erroneous claim.)

It is theoretically possible that an unwillingness of firms to raise prices would lead to lower inflation, at least for a period of time.  Thus suppose the BOJ increased Japanese NGDP at 5%/year over the next few years.  If Japanese firms refused to raise prices then real GDP would also rise at 5%/year.  At some point, however, you run out of workers; the growth in real output could not continue at that pace.

But this is not what is happening in Japan, where NGDP growth since the late 1990s has been negligible.  Slow NGDP growth (i.e. tight money) fully explains the lack of Japanese inflation since 1996.  After accounting for near-zero NGDP growth, there’s nothing left to explain from the pricing behavior of Japanese firms.

Japan’s “curious” lack of inflation

PS.  Take a second look at the graph.  It shows levels of NGDP, not growth rates.  This is one of the most mind-boggling graphs in the entire history of modern macroeconomics.  And by the way, Japan’s total population in 2020 is about the same as in 1996; so per capita NGDP is also flat.  Imagine no raise in a quarter century!  (In real terms Japan has done OK, but even there I’d say its performance has been a bit disappointing compared to countries such as the US, Australia, and Germany.)

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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