Japan’s unique response to inflation: do nothing
Despite a plummeting yen, the country is holding firm on low interest rates
About 10 years ago I interviewed the man known as the world’s greatest shoemaker at his atelier in central Tokyo. I learned that Yohei Fukuda spent around 100 hours on each pair of his exquisitely crafted bespoke offerings. And yet, as he only charged around half of what you would pay on Saville Row or Jermyn Street, he made very little profit. I asked him why he didn’t raise his prices, but he said that he simply couldn’t:
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This encounter came back to me as I followed the saga of Japan’s seemingly ossified interest rates and plummeting yen. Despite a worldwide trend in central bank increases to meet the challenge of surging inflation Japan is an outlier. The BOJ is now, since the Swiss moved, the last dovish major central bank in the world. The question is: why?
Firstly, rising prices are taboo in Japan. Any price increase is a shock to the system. Inflation may only be 2% now, but this is seen as just the start. According to the corporate research institute Teikoku databank, prices for more than 10,000 food items are set to go up by an average of 13% this year.
Given that wages have hardly risen in 30 years, this makes the inflation pill a tough one to swallow. But according to the BOJ, low interest rates are a remedy for a lockdown ravaged economy, a view perhaps carried over from the days of deflation when low rates were seen as the best way to encourage borrowing and spending.
But those in the know here in Tokyo suspect the real reason is the stubbornness of BOJ governor Haruhiko Kuroda, who wishes to see out his remaining year in post with his reputation as a low-rate governor intact, whatever the impact on the economy.
If the latter is true, it raises the question of why PM Fumio Kishida, who is a former banker himself and thus unusually economically literate for a national leader, doesn’t just dismiss Kuroda. The weakened currency has helped exporters but pushed up costs of imported goods significantly and led to strong criticism within and without Japan.
Still, this would be an almost unprecedented move, and Kishida is probably banking on the Yohei Fukuda philosophy still holding true. In this, he is probably correct. A recent increase in subway fares (up by around 10 pence) made headline news and forced apologies from Japan railways. And an ice cream maker went so far as to produce a TV commercial featuring the entire staff apologising for their first price hike (of around 5 pence) in 25 years. A bakery near me put a blackboard outside their shop explaining in detail, and apologising profusely, for a negligible increase in prices necessitated by a rise in the cost of flour. I go there nearly every day and I hadn’t even noticed.
All of this is closely related to the Japanese quality of ‘gaman’ or endurance, a handy national attribute in times of difficulty. The Japanese seem almost to relish adversity, and a little tightening of purse strings will probably be tolerated, and perhaps even welcomed, as a chance to display one’s hardiness and commitment to the nation.
This national trait has arguably been renewed and perhaps even strengthened by the pandemic. Few Japanese took the opportunity to work at home when it was offered, and almost no one has removed their face masks despite official government guidance that they needn’t be worn outside anymore.
Thus, Kishida will likely refrain as he sees no immediate need for action. His approval ratings are at record levels thanks to his reputation for decisiveness and reasonable manner.
What this means is that in the near term nothing will happen, except the yen is likely to continue falling for a while yet, and people’s lives will get increasingly harder. But with Kuroda due to step down next year, Kishida can afford to wait it out and when the time comes install a more amenable successor.
The author seems to have not heard of the explanation that you cannot limit inflation that was not primarily caused by monetary policy through raising the interest rate. The whole point of raising the rate is to curb spending. People and businesses don’t borrow to finance new purchases, and don’t spend to the limit because with the low interest rates ‘it’s not worth it to save, now, anyway’. You raise the interest rates, the demand goes away, the prices stop rising and even fall. Success. Through throttling the economy you have reduced inflation.
This does not help matters when the inflation is caused, not by excess demand, but by scarcity. When that is the problem you don’t need to change people’s minds about making purchases — they’d already prefer to not make the expensive purchases. The problem is that they need to, or at least believe they need to make the purchases despite the high prices. (For another segment of the market, the problem is that they have so much money that they pretty much don’t care what something costs.)
Now, a great many central banks have long wanted to raise rates, not to combat inflation, but because they have been so low for so long that a bank that wanted to stimulate the economy by lowering rates cannot, because they are already on the floor. Thus raising rates now, because you can get people to believe that it is because of inflation rather than because you have wanted to make this correction for a decade or more now, and here is the chance! makes good banking sense.
But the Japanese, who don’t sit up nights worrying about inflation, may be a little hard to convince that raising rates will be good in the long term, when the exporters can definitely point to the harm of having too strong a Yen, especially when your trading partners are going through hard times.
Great commentary, especially “This does not help matters when the inflation is caused, not by excess demand, but by scarcity.”
So many economists, bankers and politicians do not seem to appreciate this – they are so clever and are in control.
The classic description is “Too much money chasing too few goods.”
Who would have thought that wearing a mask is like taking part in a kabuki production.
Interesting article, though, thanks.
Japan’s efforts at sustaining, let alone establishing a global too tier investment bank have failed 3 times, as they always think that ” They know better..” but do not appear to learn from previous errors. I have a morbid fascination for the bizzarre fact that Japan had a virtual global monopoly in and on computers, electronic goods, and wireless transmission technology and yet Sony, Sanyo, Panasonic et al let “Silicon Valley” take their monopoly, when they missed/ignored the crucial technology/ digital advances…. the same applies to smartfones.
The Japanese are the very best in all the world in taking an invention, and refining it so that it is the very best X that can be. It is an amazing talent. But they aren’t very good at coming up with the new thing at all. For all that they obsess about it all the time, and stuff tons of money into coming up with the next great thing, they just aren’t very good at coming up with it.
This made for a nice partnership with Bell Labs Research whose researchers could come up with the next great thing — as well as the next not-so-great thing and the next who-ever-thought-this-would-work-at-all — but who couldn’t do product development and marketing at all. Sony, Toshiba, and other household names all got their start here.
But with the breakup of AT&T’s monopoly, the good old days (if you were a researcher for Bell Labs, which was the top research job in the whole world) of sit around, think nice thoughts, make nice experiments, produce nice prototypes, patent everything you could (which in those days needed the nice prototype) and go on thinking the next new thoughts was over. There was no everfilling bucket of monopoly telephony money to fund all the research that the very cleverest researchers in the world wanted to do.
Somebody had to make the research pay off, despite the fact that nobody in the Bell Labs/AT&T/Lucent world knew how to do that, or else they would have been doing it already. So instead of letting the researchers think about whatever they liked, they started giving them direction. But the direction was often bad, and worse the researchers discovered that Bell Labs had just become another unpleasant place to work, rather than the Holy Grail of employment destinations.
But cool things were happening in Palo Alto. Maybe we should just move there and check it out 🙂 This was good for Silicon Valley, but it meant that the Japanese couldn’t just research Bell Labs patents in order to find out what to develop next. Apparantly the ability to tell which things coming out of Silicon Valley would be the next best thing, in the absence of a ‘made by a Bell Labs researcher’ label requires the same sort of skill as you need to come up with them in the first place, reminiscent of the Dunning-Kruger Effect.
I’ve never understood the apparent ‘catastrophe’ that is the Japanese economy since the 90s because they still seem to be doing ok even as economists report they are in financial decline/stagnation. Is this the writer’s reference to their endurance giving the false impression that they are getting by?
Day to day currency movements respond to arbitrage on relative interest rates, but only while sentiment on balance of payments is neutral. When balance of payment pressures are anticipated currency movements respond to them. If Yen inflation is lower than inflation in other countries the sentiment on balance of payments will change.
As Laura Creighton points out in her comment inflation is not currently driven by greed so curbing greed with interest rates rises is pointless.
Much of current inflation is energy prices from the own goal of sanctions against Russia. They have increased prices but not reduced Russian sales. Russia has increased its revenues and Europe has suffered unnecessarily. There is no world shortage of fossil fuels to hold prices up so they will go down, more so if the supply of renewable energy exceeds the increase in demand for energy.
The role of sentiment in economics is rarely fully appreciated. Interest rates are a blunt tool to try and alter sentiment which can be dwarfed by other factors.
Thatcher drove up unemployment to reduce inflation but she also talked the economy up – it would have been better to talk it down.
Wait until they give up on yield curve control. There will be no announcement (almost necessarily) – it will just happen. The yen is going to get ground into dust.
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