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In Japan, a Debilitating Lack of Options to Fight Deflation

The economist Milton Friedman once famously proposed scattering money from a helicopter to get consumers to spend their way out of deflation — the debilitating decline in prices and wages that can act as a deadweight on economic activity.

Copter cash may not yet be among the tools considered by the Japanese central bank in its quest to lift the country out of a long deflationary slump. But pressure is mounting on the Bank of Japan for more drastic action.

Last week, the deflation doldrums that have becalmed the Japanese economy for much of the past decade helped knock Japan from its long-held ranking as the second-largest economy. (China edged up to No. 2, behind the United States.)

Bank of Japan
AP
Bank of Japan

And recent signs of a Japanese recovery now seem to be fading: The economy grew an anemic 0.1 percent between April and June. Meanwhile, a strengthening yen, which hurts Japan by making its exports less competitive, has many people calling for the bank to further ease its monetary policy to shore up the economy — if not outright government intervention in currency markets.

But on Monday, hopes for decisive action were dashed when Prime Minister Naoto Kan and the governor of the Bank of Japan, Masaaki Shirakawa, opted not to hold a widely anticipated meeting, but instead engaged in a 15-minute phone call in which the two did little more than agree to “communicate closely with each other.”

“There was absolutely no talk” of currency intervention in their conversation, said Yoshito Sengoku, the government’s top spokesman.

Following Mr. Sengoku’s comments, the Nikkei stock index slipped 0.68 percent, to 9,116.69, its lowest close this year. The yen continued to hover close to 15-year highs, or around ¥85.35 to the dollar.

“The government has again taken a wait-and-see attitude,” said Norio Miyagawa, asenior economist at Mizuho Securities Research and Consulting. “The truth is, there are no quick fixes, but markets are disappointed that they got nothing at all.”

Indeed, while Japanese economic officials have long been accused of moving too slowly and timidly, they now seem to have few good options, whatever their will for pursuing them.

In the United States, there has been considerable debate about whether the U.S. economy faces a similar deflationary risk and whether the Federal Reserve should be doing more to guard against falling into the same trap.

Some of those fears may well be overblown, but a widely read paper by James Bullard, the Fed’s regional bank president from St. Louis, has warned that the U.S. economy faces a risk of becoming “enmeshed in a Japanese-style deflationary outcome in the next several years.”

Japan’s experience shows that deflation can creep up on an economy — and can be extremely difficult to shake.

In Japan, companies remain unsure of how much to invest, because deflation makes it unclear how much they can sell — and for how much. Households have little incentive to spend, knowing goods and services will get cheaper the longer they wait.

That lack of spending, in turn, is deepening Japanese deflation, as companies are forced to decrease prices in a desperate bid to attract buyers.

An aging, dwindling population has further sapped demand. So have widely held fears over jobs, wages and pensions, which are prompting consumers to hunker down and save instead of spend. “Zombie” companies, propped up by rigid regulations and comfy ties with banks, leave little space for newer companies that might take more investment risks, offer more innovative products and services, and stimulate demand.

“Japan’s deflation is not caused by a lack of liquidity or high interest rates,” said Masaaki Kanno, chief economist at JP Morgan Securities Japan. “The problem is that people and firms do not want to spend money.”

Any opportunity for fresh stimulus spending is limited by a $10 trillion public debt that is twice the size of the Japanese economy, as well as an impasse in the country’s Parliament.

Mr. Kan appeared to back away Friday from recent talk of more stimulus, instead indicating that he would lean on the central bank to do more to sustain Japan’s recovery. “We need to think more about ways to boost the economy that don’t rely on pump-priming,” Mr. Kan said.

The central bank’s options are also limited. With the main interest rate under its control — the so-called policy rate — at 0.1 percent, the bank has little leeway to lower rates further. That limits the bank to measures like buying up long-term government bonds, or pumping more short-term financing into banks, an approach it introduced in December.

But consumer demand in Japan has become so weak — and deflationary expectations are now such the norm — that the economy seems no longer to respond to such monetary tools.

“The market may soon realize just how few options Japanese authorities have left.”

After Japan’s storied economic run-up of the 1980s became a speculative bubble that burst in 1990, it took about four years for its economy to hit the bottom. It then took another four years for deflation to take hold.

Not until 1999 did the Bank of Japan respond by lowering its policy interest rate to zero. By that time, however, the economy was so depressed that not even zero interest rates could induce recovery.

Only when the central bank in 2003 began sharply increasing its purchases of financial assets to flood the economy with more money was the stage set for a gradual recovery. And yet, despite stable economic growth of 2.5 percent from 2004 through 2007, the deflation glacier did not completely melt: The decline in the consumer price index, a measure of deflation that tracks the average price for a basket of goods, slowed but did not disappear.

Still, emboldened by a nascent recovery, the Bank of Japan began raising its policy rate in July 2006, bringing it to 0.5 percent by the following March — a controversial step that some economists and politicians, called premature.

Before that debate could fully play out, the global economic crisis ravaged Japan’s export markets, plunging the country into its worst recession since World War II. In 2008, the Bank of Japan again slashed interest rates, to 0.1 percent.

Now, an upward swing in the value of its currency is adding to the country’s woes by threatening its export-led economy, making Japanese goods more expensive overseas and eroding the value of Japanese corporate earnings. The yen tends to strengthen against other currencies despite weaknesses in the Japanese economy because the country continues to chalk up current-account and trade surpluses.

The yen has risen about 8 percent against the U.S. dollar in the past three months, and it recently hit a 15-year high of ¥84.73 before weakening slightly.

The Bank of Japan could mitigate the yen’s damaging rise by further easing monetary policy, lowering long-term interest rates, buying up long-term government bonds or supplying banks with more short-term financing.

The lower interest rates are in Japan, the bigger the potential difference between rates in the nation and elsewhere, giving market players more incentive to sell the yen to invest in other currencies. But as long as rates are nearly as low in other countries, including the United States and the euro zone, there is little motivation for currency traders to abandon the yen.

In recent days, government ministers have openly called on the central bank to do more to ease the rise in the yen.

“The monetary authorities should send a strong message that the yen is too strong,” Seiji Maehara, the influential minister of land, infrastructure and transport, said Friday.

But analysts doubt how aggressive the central bank will be, given its widely known discomfort for a monetary policy that has stayed so easy for so long.

“We think that the market is pinning rather too many hopes on countermeasures” to deflation and the yen’s rise, Taisuke Tanaka, a strategist at Nomura Securities in Tokyo, wrote in a note to clients this week. “The market may soon realize just how few options Japanese authorities have left.”

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