“Japan appears to have finally embarked on a path towards overcoming deflation,” said Hiroshi Nakaso, deputy governor of the Bank of Japan (BoJ). Nakaso outlined Japan’s history of deflation and his outlook for the country’s future at a luncheon organised by the Swiss Chamber of Commerce and Industry in Japan and supported by the EBC and the American Chamber of Commerce in Japan.
Nakaso described how the seeds of deflation were set after the bursting of the asset bubble in the early 1990s, when the BoJ lowered its benchmark interest rate to a mere quarter of a percentage point. Without the central bank functioning as an intermediary, “deflation persisted, deflationary expectations became entrenched, and economic behaviour based on the assumption that prices would not rise or would moderately decline took hold,” said Nakaso. As prices, sales, wages and profits continued to decline, “the economy tumbled into a vicious cycle … therefore, what is critical is not to allow deflation to take hold for too long. This is one of the important lessons we have learned,” he added.
In order to combat deflation, Nakaso said inflationary measures must be boosted. Currently, the BoJ is pursuing this strategy by purchasing huge amounts of government bonds, through which it aims to double the nation’s monetary base in two years. The central bank expects the move to lower real interest rates and, in turn, stimulate the economy.
According to Nakaso, the strategy has been successful following its implementation last year. In 2014, Japan’s economy is set to achieve solid price stability; interest rates are stable, and inflationary expectations are on the rise. “As a result,” said Nakaso, “real interest rates have declined, thereby stimulating private demand. Against this backdrop, the virtuous cycle among production, income and expenditure has kept the growth momentum intact; and Japan’s economy has continued to recover moderately. Real GDP growth has been positive for six consecutive quarters.”
Though Nakaso remains positive about the outlook for Japan’s economy, he emphasised that there is urgent need to strengthen the economy’s growth potential. The BoJ deputy governor pointed to demographic changes that have led to a decline in labour input, and to Japan’s economic crash that weakened the ability of domestic firms to accumulate capital and to adapt to global advances in IT.
“If the economy can escape from its deflationary equilibrium and shift to one in which inflation of about 2% is sustained in a stable manner as we envisioned, that will revive the animal spirits of firms and households, and promote proactive investment and innovations.”
In order to raise Japan’s growth potential, Nakaso said that “it is essential to enhance labour supply capacity by raising the labour participation of women and the elderly — as well as utilising high-skilled foreigners — encourage forward-looking investment by firms and increase capital stock, and raise productivity through regulatory and institutional reforms.”
Nakaso’s recommendations are reflected in Prime Minister Shinzo Abe’s Japan Revitalization Strategy — the third “arrow” of Abenomics — which was announced in June. The administration’s economic plan aims to “regain earning power, reinforce [the] workforce, and develop industries that play central roles in local economies.” Nakaso praised such economic reform, deeming it “commendable”.
“I strongly hope that the government will continue to implement the growth strategy unwaveringly,” said Nakaso.