Figure 1

The Inflation rate BoJ and government are fighting

Introduction

These graphs (see figures 1) describe the past and the possible future forecast trend of the Japanese inflation rate; the right hand graph represents the core Consumer Prices Index (CPI) and is mainly discussed here. The core CPI presents the change in the price of goods and services except for the food and energy sectors, which are quite volatile and therefore most market practitioners strongly believe they should not be included in such economic measurements. However, the headline inflation rate can be included in them, which seems to be the nominal inflation rate that best reflects actual people’s purchasing power.

Importance of Inflation Rate

Most economists believe that a rising Inflation rate can be important for a national economy because the nominal gross domestic product (GDP), which is defined as the real GDP plus the inflation rate, can reflect the national wealth. This means that if the GDP grows faster, people will become richer (and may be happier). However, Japan’s nominal GDP growth rate, which was almost zero, was slower than other countries, even other advanced economies such as in the UK and United States for about 20 years since 1995.

BoJ Challenge

The Bank of Japan (BoJ) and the jJapanese government have been struggling to increase the inflation rate (the core CPI) to the target rate (2.0%) by using monetary policies such as quantitative easing since April 2016. This is because Japan suffered deflation from 1995 to 2016. During this period, It is apparent from figure 1 that the trend of the core CPI or inflation rate (see figure 1) fluctuated between -0.5% and 1%. Owing to this, the target inflation rate could not be realized. In addition, the future inflation rate will still not reach the target within five years. This can be demonstrated by the current five-year inflation swaps rate which reflects the market expectation for the future inflation rate, when it is still below 2.0%. This means traders believe that even in the longer term the Japanese inflation rate is quite likely to be below the target.

Most market participants analysts agree with the view that the lower inflation rate can result in a lower bond yield because there is a strong relation between the inflation rate and government bond rate, which seems to be equal to the interest rate or deposit rate. In Japan, the lowest Japanese government bond (JGB) yield has actually reached a minus rate, for example, -0.1%.

Once Shirakawa, who was the former governor of the BoJ, took a position that they have no capability to control the inflation rate until April 2016. On the contrary, Kuroda, who took over the governorship of BoJ and Abe, who is the current prime minister of Japan, argued that BoJ can manage this rate using the monetary and fiscal policy, so called Abenomics, which started then and was supported by the “Reflationist” economists. However, they still could not control the inflation rate in spite of the fact that they took all measures they could such as purchases of private sector assets, in particular, the equity ETFs and JGB, therefore, some people, especially the anti-Reflationist economists criticized Abe, Kuroda and the Reflationist economists.

MMT and Economic schools

The answer of which school is more likely to be correct is further complicated by the existence of a new school called Modern Monetary Theory (MMT). The MMT school and the Reflationists argued that the government annual budget constraint might frustrate achievement of the target inflation rate. This is because they believe the government is fearful of deteriorating the primary surplus which occurs when the government taxes more than it spends.

Most mainstream economists said that If the primary balance worsened and became a deficit, uncontrollable inflation would occur due to the sharp increase of JGB rate, which means if investors are concerned about debt sustainability, they would never buy JGBs. In addition, they said that while the BoJ and government might be able to cause inflation, they could not control the rate. They also pointed out that at one time Japan experienced hyperinflation, which was almost 40%, only after World War II. However, the MMT school argued that as long as a country such as Japan, the UK and the United States borrows in its own currency and can do so, they will never fall into bankruptcy because they have a central bank and the bank can create money.

Japan and Europe’s Economic Situation

Japan is also concerned about aging and its population decrease, especially the labor force, which has already reached the peak. In addition, most pensioners may want there to be deflation. There are quite many and if inflation occurred, their purchasing power would decrease due to the lapse of the inflation slide of the social wealth system, which means even if the inflation occurs, the amount of a pension payment will not be counted in this situation immediately. In addition, some investors think in terms of the consolidated government, which is the state’s and the central bank’s balance sheet taken together, Japanese primary deficit has been almost balanced. This can be one of the main reasons hyperinflation has never occurred in spite of the fact that Japanese government’s primary deficit Is about 2% of GDP and government debt is huge, which amounts to about 200% of GDP. Furthermore, this is supported to the fact that the Japan 5 Years CDS value is 23.1 (as of 1 June 2019), which means the market practitioners believe there is only a 0.39% implied probability of default.

The low inflation rate problem is not only in Japan but also in the Eurozone, in particular, Germany. The German government bond rate reached almost zero percent, which is quite similar to the JGB yield. Some economists have recognized that the Euro zone, particularly Germany, Spain, Italy and France has been Japanizing. In addition, they do not have their own central bank, therefore, they cannot deliver the monetary policy separately which means fiscal policy is the only measure to stimulate their economy. However, the EU restrict countries’ primary balance, therefore, some European countries, especially Italy, having a huge primary deficit have almost no option to do so.

Now Japan has also the primary deficit then has a few measures to stimulate the economy, which means what Japanese government should prioritize in terms of spending can be important. They have planned to increase the minimum wage and to put up the consumption tax rate, which is quite similar to the value added tax (VAT), from 8% to 10% in October. In addition, Olivier Blanchard and Takeshi Tashiro, who belongs to The Peterson Institute for International Economics (PIIE), suggested they should spend money to raise the fertility rate because they calculated if increased in the fertility rate from 1.45 (current Japanese rate and about 0.2% higher than Italian and Spanish rate) to 1.80 (almost the same as British and American rate) GDP would be about 6% higher in 30 years and 17% higher after 50 years. This means the information rate can increase as the fertility rate rises.

Conclusion

Some people said that today Japan can be an experimental station for fiscal-monetary policy. If the Japanese government can manage the inflation rate, other countries such as Europe would also be saved.

Reference