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Weak Yen to hurt Japan in the long run?

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An Inflation rate between 2.8% to 3% amid the global economic slowdown is something that every country is dreaming of right now. Only one country had it till September, after that the ratio went up to 3.4%. The nation under discussion here is Japan. Out of the Group of Seven (G7) countries, Japan currently has the lowest inflation.

However, its official currency yen reached its 32-year low against the dollar. The crucial factors behind these are the widening interest rate gaps between the US and Japan, along with the latter’s trade and current account deficit.

Japan’s history of low inflation
Despite its destruction in the Second World War, Japan in 1960 had a per capita GDP of around USD 8600, about one-third of the US. The same figure touched the USD 35000 mark by 1988 and surpassed the US on this front.

The average per capita growth in Japan was 5.2% in 1988 alone. However, after the 1989 Tokyo stock market crash and the 1992 asset price bubble burst, the US overtook the Asian country in terms of per capita income and it widened further. As per the 2018 stats, the US per capita income was USD 55,000, while Japan’s was USD 49,000. The Asian country’s average per capita GDP growth figure from 1998-2018 was only 0.76%.

However, one noticeable thing about Japan is its consistently low inflation. In the 1980s, it was at 2.5%, came down to 1.2% by the 1990s and in the early 2000s, became deflation, averaging from -0.2% to 0.5% in 2019. During COVID, the parameter turned negative again.

It rose from 0.1% in 2021 to 2.6% in 2022. Also, from 1992 to 2021, consumer goods prices rose only by 6% in Japan as against the nearly 80-90% ones in the UK and US.

Roles of Abenomics and wage rule behind low inflation
In 2012, after coming into power for the second time, late Japanese PM Shinzo Abe came up with “Abenomics”. It was about increasing the country’s money supply, boosting government spending, and infusing the essence of competitiveness in the economy.

From 2013-2018, Japan’s monetary base expanded through government-backed easing. It was done to disrupt the prolonged strong yen and deflationary recession that haunted Japan from 1993 to 2013 beginning.

The beneficiaries of the monetary policy easing were large exporting companies and the wealthy as they reduced wages and raised the consumption tax. There was no increase in average household incomes, affecting consumer behavior.

During COVID, the government spent large amounts of capital to keep the economy running. It used only a small amount of money on the household support front. With prices remaining moderate and no wage hike, Japan lowered the risk of severe inflation back then.

Japan’s average wage rate ratio has remained the same since 1992. As per the data of the Organization for Economic Cooperation and Development (OECD), the Asian country’s average annual individual income is ranked 24th out of 35 nations. Among G7 members, it is the second lowest.

With food and energy prices rising in 2022 and not the average salaries, an average Japanese household can find meeting its daily ends very difficult.

As per the Focus Economics report, the weak domestic demand is related to low wages. Over a third of all jobs are either part-time or contracted ones, with the labor unions focussed more on the job security front.

However, with inflation severely affecting the best of economies in the world right now, this pattern may change in the coming days as either the business leaders will have to effect some salary raise for their staffers or the unions will have to toughen their stance on the matter to ensure that the basic salary scale is matching the positive inflation metrics or in the best case, outpacing the latter.

While the nation opted for the gradual easing of pandemic curbs, resulting in slower economic recovery and a delayed yet significant post-COVID demand increase, as explained by Yasumune Kano from policy think tank Chatham House, these moves will only hold back the arrival of global inflation, instead of completely avoiding it.

Bank of Japan’s love affair with negative interest rates
The Bank of Japan has a monetary policy different from that of the US or UK. For the Bank of Japan, it’s all about going after monetary policy easing as opposed to the western counterparts, whose primary weapon against inflation is aggressive rate hikes. The Japanese central bank has the distinction of being the only major financial institution with a negative interest rate policy.

A Moneycontrol report perfectly sums up the BoJ’s situation. It has this constant juggling act between low inflation and deflation. From negative interest rates to large-scale stimulus, it tried everything. While the inflation rate stayed on the negative scale during COVID, it became positive in September 2021 and rose to the 2008 level of 2.5%. The bank’s short-term policy rate remains at an ultra-low level. It eyes buying of bonds and keeps the 10-year interest rates in that area at zero percent.

Talking about deflation, it’s a phenomenon where people ‘believe’ that consumer products will get cheaper as time passes by and stall the consumption behavior growth. The overall economy slows down due to poor demand. While all the other central banks raise policy rates to lower aggregate prices, Japan’s deflation scenario calls for increasing aggregate prices.

Bank of Japan Governor Haruhiko Kuroda recently justified his bank’s policy stance by citing three reasons. First is the country’s slow recovery from COVID, second has been poor Gross National Product (sum total of all Japanese nationals’ incomes, excluding the non-citizens living in the country) growth. As against the 2021 GDP growth of 2.5%, Japan’s GNP was around 0.6%. And the final factor cited by him was high energy prices.

As per a recent study, the rising inflation in Japan is due to the external supply factor, compared to the United States, where the same ratio is nearing 9% due to higher demand and lower supply.

When the interest rate or the cost of borrowing money goes down, the citizens spend more. In Japan, it’s completely the opposite. As per Bloomberg, the interest rate in the Asian country has been at -0.1% since 2016. The same rate, since 1995, never crossed the 0.5% mark.

The report also cites Japan’s aging population behind this low consumer demand and this factor is helping inflation to remain low. This section of the population is keeping more money at hand as the savings policies don’t offer lucrative returns due to the negative interest rates.

During an interaction with International Finance, Professor Robert Dekle, faculty member of the economics department of the University of South California, said, “The high costs will raise Japanese producer costs and they will raise their prices, hurting consumer demand and GDP. If the country is worried about the weak yen, it will have to raise interest rates. But the weak yen has benefits like promoting exports and tourism as well, and shifting demand to Japanese products. Whether the weak yen on the net will hurt Japan is an open question.”

Talking about the Bank of Japan’s distinction of sticking with the formula of easing monetary policies and whether that will help the country to fight inflation this time around, Professor Robert Dekle said, “The inflation rate is still low, and the economy is still weak, so Japan will try to muddle through with the low interest rates, despite the weak yen.”

“No, the higher minimum wages will worsen inflation by raising wages and producer costs,” he replied, when asked about the Japanese government’s plan about introducing a ‘Minimum Wage Hike’ policy.

Japan’s tight state controls to deal with price rises
Along with the Bank of Japan’s monetary policy easing stance, Japan is also known for its government control to limit consumer goods and services price volatilities.

Electricity and natural gas prices follow the gradual revision process and the utility providers go for long-term supply contracts. They only pay a yearly premium to ensure price stability, petrol prices have been subsidized recently.

While the world is suffering due to the surge in wheat prices, thanks to the Ukraine war, Japan is immune from its side effects as the product is imported by a government entity that follows the principle of fixing a six-month uniform market resale price range. Japan imports mainly from the US, Canada, and Australia. In 2022 June, this import cost exceeded the resale price, effecting a subsidy-kind of situation for the domestic consumers.

While Japan may go for a bigger and more prominent “bread and noodle subsidy” as the Ukraine conflict rages on, the slow lifting of COVID curbs also ensures that the post-pandemic demand increase will keep the country’s inflation down for some more months. Still, there is a shift towards sustained inflation for Japan’s economy and the “cost of living” emerged as an issue during the recently concluded House of Councilors election.

The Bank of Japan said that future debates on its monetary policy will revolve around short-term interest rate hikes and the central bank’s balance sheet health. So, it needs to be seen whether the Asian powerhouse goes for an economic policy change and if it happens, how drastic it will be.

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