Japan: a sleeping beauty

On the macroeconomic scale, Japan is a laboratory, but it’s also a cemetery where economists and theorists have had to bury their certainties. I salute the determination of Prime Minister Abe on his departure, having not shied away from any decision or measure in pulling his country out of the lethargy that it has been mired in for thirty years. This inflation-related issue that the leaders of Japan have had to deal with for decades is, however, more relevant to our Western nations than ever. The president of the US Federal Reserve, Jay Powell, has just declared, rather revolutionarily, that his central bank will do everything it can to bring the national rate of inflation back above the targeted level of 2%.

A global battle has thus been raging on pretty much since the deflationary episodes of the 2010s in an attempt to relaunch economies by dint of inflation. In this respect, the Japanese experiment, or rather multiple experiments, remains a case study to show that inflation is still proving a difficult spectre to revive. Japan has tried everything, holding massive public deficits for decades along with nearly-zero interest rates, the combination of the two –a horrifying idea –not sparking any inflationary agitation. The Bank of Japan (its central bank) has therefore had to keep rolling its objective of reaching 2% over to the next year.

Every theory has come up against a brick wall in Japan, like Milton Friedman’s monetary theory, because the increase of the amount of money in circulation has not in any way had the intended or predicted effect there. Probably because of their demographic decline, the Japanese haven’t been spending more – and therefore haven’t caused inflation – despite the ever-increasing quantities of money at their disposal that gets poured into the system. Also, the belief held by many economists– the wrong one in my opinion –that teaches that the worsening of debts and deficits has an ingrained, and of course harmful, effect on inflation has been torn to pieces, since it is indeed a perpetual zero inflation rate that has been seen alongside Japan’s deficits being eaten into beyond the point of no return.

The famous “Phillips Curve” didn’t fare any better, having drawn a plausible link between the employment rate and inflation, but that found itself torn to shreds in Japan, where full employment coexists harmoniously with a low inflation rate. The basis of this law of Phillips’ – that is not a theory but that follows in line with reality in other circumstances and in other places – proves, however, that a dynamic labour market leads to a rise in wages, that in its turn revives consumer prices via aggregate demand. Also, the arrival of Shinzo Abe in 2012 brought with it unprecedented structural measures for Japan that might have been enough to increase inflation, like the widespread introduction of women onto the job market, whose quantitative and qualitative combination caused the unemployment rate to drop to less than 3%…without, however, having any upward influence on salaries or prices.

We too, in Europe and the US, must learn to live without inflation. After all, Japan isn’t doing so badly, with its economy nevertheless managing to create growth and maintain full employment, despite the absence of pressure on prices and wages. From my point of view, this growth without inflation that Japan is going through is an ideal phenomenon for our intertwined, post-modern and highly digitalised economies. The price stability that now reigns over our economies – mainly through this health crisis and the shakes and panics that have come with it – is a notable factor in reducing uncertainties for workers, companies and investors. In many ways, Japan now finds itself in the most enviable of situations as it enjoys a deflationary boom: it’s a rare phenomenon, but one that must be appreciated for what it has to offer, because it shows to the most reluctant and the biggest critics – like the monetarists – that it really is possible to have growth without inflation. Of course, the Sword of Damocles is a likely threat to Japan and its massive public debt that the return of a certain level of inflation could markedly reduce, and that does not however prevent its citizens from enjoying their growth without inflation in peace.

Whatever the case, Japan is acting like a bearer of harsh truths for the orthodox economist, so that he might try to understand this inflationary phenomenon since it has shaken up all the accepted ideas and contradicted all the theories. The case of Japan forces us all to have a deep rethink and questioning of what we have always learnt about inflation, a fundamental link in the chain of macroeconomics.  And it is urgent to review the fine print because very low, even zero or negative, inflation – that has been the salient point of our economic backdrop since 2008 –is here to stay, despite the combined efforts of our central banks that do however possess a formidable arsenal. I’ve been saying it for years that we are now all like Japan – this sleeping beauty that many a prince has tried, and failed, to wake from its lengthy slumber.