Inflation? Not in Japan. And That Might Maintain a Warning for the U.S.


TOKYO – Everyone in the United States is talking about inflation. The reopening of the country after the coronavirus pandemic has sparked a backlog for everything from raw materials like wood to used goods like used cars, driving prices up at the fastest rate for over a decade.

However, Japan has the opposite problem. Consumers pay less for a lot of goods, from uniqlo parkas to steaming hot bowls of ramen. While average prices in the United States rose 5.4 percent last year, the Japanese economy was under deflationary pressure, with prices slumping 0.1 percent in May compared to the previous year.

To some extent, the situation in Japan can be explained by the ongoing battles with the coronavirus that have kept shoppers at home. But deeper forces are also involved. Before the pandemic, prices outside of the volatile energy and food sectors had barely moved for years as Japan never came close to meeting its long-term target of 2 percent inflation.

It wasn’t because there was a lack of trying. For nearly a decade, Japanese politicians have used almost every trick in the economists’ book to drive prices up. They have juiced the economy with cheap money, spent huge sums on fiscal incentives like public works, and lowered interest rates to levels that made borrowing nearly free.

But, as Japan learned the hard way, low inflation can be an economic quagmire. And that experience is a warning to the United States if its current inflation spurt wears off, as many economists anticipate, and its economy falls back into the cycle of weak inflation that preceded the pandemic.

“Most economists, myself included, are pretty confident the Fed knows how to bring inflation down,” said Joshua Hausman, an associate professor of public policy and economics at the University of Michigan who studied Japan’s economics.

“However, due in part to the experience of Japan, it is much less clear that we are very good at raising inflation,” he added.

To consumers, falling prices sounds like a good thing. But from the point of view of most economists, they are a problem.

Inflation, they like to say, lubricates the gears of the economy. In small amounts, it increases corporate profits and wages and stimulates growth. It can also reduce the debt burden and lower the relative costs of college loans and mortgages.

Japan’s inability to raise inflation is “one of the biggest unsolved challenges in the industry,” said Mark Gertler, an economics professor at New York University who has studied the subject.

A popular explanation for the country’s troubles is that consumer expectations of low prices are so entrenched that it is virtually impossible for businesses to raise prices. Economists also point to declining demand caused by Japan’s aging population as well as globalization, with cheap, plentiful labor effectively keeping costs down for consumers in developed countries.

The picture once looked very different. In the mid-1970s, Japan had one of the highest inflation rates in the world at almost 25 percent.

It wasn’t alone. The soaring prices sparked by the 1970s oil crisis defined the era, including for a generation of economists who believed that the most likely threat to financial stability was rapid inflation and that interest rates were the best way to combat them.

But in the early 1990s, Japan began grappling with a different problem. An economic bubble burst, fueled by a rising stock market and rampant real estate speculation. Prices started to fall.

Japan addressed the problem with innovative measures including negative interest rates to encourage spending and pumping money into the economy through large-scale asset purchases, a policy known as quantitative easing.

It seemed to be of little use. However, the economists of the time saw Japan’s experience not as a warning to the world, but as an anomaly caused by bad political decisions and cultural idiosyncrasies.

Daily business briefing


July 15, 2021, 1:00 p.m. ET

That began to change with the 2008 financial crisis, when inflation rates plummeted around the world and other central banks introduced quantitative easing measures.

The problem is most evident in Europe, where inflation has averaged 1.2 percent since 2009, economic growth is weak and some interest rates have been negative for years. In the same period, the US inflation rate averaged just under 2 percent. The Federal Reserve has kept its key rate near zero since March 2020.

Some prominent economists saw low inflation as a sign that the US and EU economies could be on the verge of so-called secular stagnation, characterized by low inflation, low interest rates and sluggish growth.

They feared that as both economies turn gray, these trends would deepen, potentially reducing demand and increasing savings rates.

In 2013, under the newly elected Prime Minister Shinzo Abe, Japan began its most ambitious efforts to tackle its weak economic growth and low inflation.

The government started a big experiment with huge monetary and fiscal stimulus, bought huge amounts of stocks and cut interest rates in hopes of encouraging borrowing and putting more money into the economy. As the supply of cash increased, it was thought that its relative value would decrease, effectively driving up prices. Fed up with money, consumers and businesses alike would spend more. Voilà, inflation.

To encourage spending, Japan passed a policy known as forward guidance, which aims to convince people that prices would go up as it vowed to do everything in its power to meet its 2 percent inflation target to reach.

But the government’s persuasion efforts were unsuccessful, so there was little urgency to spend money, said Hiroshi Nakaso, a former deputy governor of the Bank of Japan and head of the Daiwa Institute of Research.

Japan is in a vicious circle, said Takatoshi Ito, a professor of international and public affairs at Columbia University who served on Japan’s Economic and Tax Policy Council.

Consumers expected “stable prices and zero inflation,” he said, adding that “companies are afraid of price increases because it would attract attention and revolt consumers”.

The sluggish economy has led companies to raise wages, he said, “and because real wages have not increased, consumption likely has not increased, so demand for products and services has not increased.”

With inflation barely moving, some economists wondered whether Japan’s stimulus was too conservative, despite the fact that it was causing one of the largest debt burdens in the world.

Policymakers cited the need to pay off the country’s debts and meet the rising costs of caring for an aging population, and backed up against the expense by raising the country’s consumption tax twice, which appears to have weakened demand.

In the end, Mr. Abe’s experiment, known as Abenomics, may not have been as successful as hoped. But it has informed policy makers’ response to the pandemic, said Gene Park, a political science professor at Loyola Marymount University in Los Angeles who studies Japan’s monetary policy.

One lesson, he said, is that governments could spend more than they ever thought possible without triggering a rapid spike in inflation. Another reason is that they may have to spend significantly more than they previously thought was necessary to fuel growth.

Japan “has given the US more freedom to experiment with bolder measures,” said Park.

Japan also tried to apply the knowledge gained since 2013 during the pandemic. The government has paid shops and restaurants to keep them closed, distributed cash to everyone in the country, and financed interest-free loans for troubled businesses.

The prices fell anyway. It did so in part at the behest of the government itself, which recently pressured telecommunications companies to cut cell phone charges that it believed were too high. Most Japanese consumers are also still waiting for a vaccination against the coronavirus, which is slowing economic activity.

However, even after the pandemic subsides, Japan’s inflation rates are likely to remain low, said Sayuri Shirai, an economics professor at Keio University in Tokyo and a former board member of the Bank of Japan.

After all, the main problem remains unchanged: Nobody is really sure why prices stagnated.

“The central bank probably doesn’t want to say that it can’t control inflation,” said Ms. Shirai. “That’s why this topic was simply left without a clear discussion.”