The New York Times recently reported that the Japanese authorities are once again trying to stimulate a rather moribund economy with injecting more money into the circular flow.
* A ¥11 trillion is to be added to an asset buying programme
* The Bank of Japan will supply banks with cheap long-term funds in the hope of stimulating borrowing.
* Base interest rate to stay at 0-0.1% – see graph below
* These measures will stay in place until inflation has reached at least 1% – Bank of Japan forecast of this figure is March 2014.
There has been some return to growth with the reconstruction after the 2011 earthquake and tsunami. However global demand has declines and the issue of territory with China hasn’t helped – Japanese goods are not being favoured by Chinese consumers. Japan’s deflationary decade hasn’t been helped with a contracting population and monetary policy needs to be accompanied by government fiscal policy as private sector companies don’t have the confidence to invest in major expansions. To this end the government have thrown money at the economy to the tune of ¥422.6 billion (in the form of government spending) but this is already twice the size of the Japanese economy. A strengthening yen hasn’t helped matters as exporters find their products uncompetitive.
The recent CPI figures published by the Dept of Statistics in Wellington show that there was a 1% in the CPI from the June 2011 quarter to the June 2012 – the lowest annual rise since 1999. This is at the bottom of the Policy Target Agreement which stipulates that the CPI should be kept between 1-3%. The question now is whether annual headline CPI inflation can avoid dipping below the bottom of the 1.0% and whether the threat of deflation is a serious concern?
Deflation – why is it a concern?
In the short-term a period of deflation can help the economy. Falling prices mean that consumers can buy more with their income and rising purchasing power would provide a boost to confidence and could assist the economy by increased growth.
However a longer period of deflation can be very damaging to an economy for two reasons:
1. Expecting prices to be lower in the future consumers put off purchasing goods and services in the expectation that they will get lower. This leads to a contraction of demand and ultimately lower growth. Japan in the 1990’s is a good example of this – see graph below.
2. A more dangerous scenario is debt deflation. As prices fall the real value (nominal – CPI) of debt increases – just as it decreases if prices are rising.
The increase in debt that people have taken on over the last 5 years makes this latter point very worrying. However, commentators have suggested that deflation shouldn’t become a problem in NZ.
The 2011 March quarter GDP figures were quite amazing when you think of the tragic earthquake in the Christchurch area last February. The economy grew 0.8% (0.4% forecast) which signifies that the economy outside of Christchurch is very strong. If you compare the data from the other recent natural disasters, being the Queensland floods and the Tohoku earthquake/tsunami, New Zealand has actually grown – see figures and graph below:
* Australia had a 1.2% drop
* Japan had a 0.9% drop
The NZ$ and QE3
Also the NZ$ keeps motoring ahead – yesterday reaching US$0.85. However, with the official cash rate at 2.5% one wonders what is the currency reacting to? Most likely it was:
*the better than expected Q1 GDP figures outlined above and
*the words of US Fed Chairman Ben Bernanke who strongly suggested the US economy was in need of some more serious antibiotics in the guise of QE3 – Quantitative Easing 3 in which the Fed bascially print money.
Bernanke indicated that QE3 would depend on two conditions, economic weakness beyond current expectations, and a renewed threat of deflation.
The Fed is charged by Congress with minimizing unemployment, and some of its critics say that current unemployment rate of 9.2 percent should be a sufficient reason by itself for the central bank to expand its roster of economic aid programs.
Mr. Bernanke noted that the scale of the Fed’s existing efforts was unprecedented. The central bank has kept short-term interest rates near zero for more than two years. It also owns more than $2 trillion in mortgage-backed securities and government debt, the legacy of its two asset-purchase programs to reduce long-term interest rates.
New York Times
Future worry for NZ economy
These figures indicate strong underlying growth in the NZ economy but there are concerns about capacity contraints if the economy is to grow more. And if this is the case there will be significant pressure on prices and a sooner than predicted OCR increase by the RBNZ.
I am off on holiday for a week and will resume service on Monday 25th July.
The Guardian newspaper recently produced a useful article about inflation. Although UK based it covers issues such as: stagflation; a historical look at inflation globally (see below); is high inflation good for anyone; why do governments target inflation. Click here for the article.
The record of the highest inflation globally was long held by Germany in the Weimar Republic years when money was carted around in wheelbarrows. In December 1923 prices were more than 85,000,000,000% higher than a year earlier and the highest denomination bank notes had a face value of more than 1,000,000,000,000 marks. In post-revolution Russia, inflation reached 60,804,000% that year – some economic historians believe the government deliberately stoked inflation to impoverish the better off.
But after the second world war, Hungary suffered the highest inflation ever recorded. In the peak month of July 1946, prices were doubling in little more than 12 hours. Other countries that have seen sky-high price rises include China during the civil war from 1945 to 1949, Greece in 1944, Argentina in the 1980s and war-ravaged Yugoslavia in 1994.
More recently, Zimbabwe made headlines for soaring inflation, with price rises hitting 66,212% in December 2007 – the highest inflation in the world at that time. The highest denomination bank note had a face value of 10,000,000 Zimbabwe dollars.
By contrast, Japan experienced a long period of deflation during the “lost decade” of the 1990s.
From the Wall Street Journal – criticisms Ben Bernanke made of Japan’s central bank a decade ago—saying it was too timid in stimulating Japan’s economy to prevent deflation—give hints of what the Fed’s next steps might be. As a Princeton professor in the 1990s, Ben Bernanke lectured Japanese officials for mishandling their economy. In a 1999 paper, Mr. Bernanke lashed out at Japanese officials, saying their country’s woes were the result of their own “self-induced” paralysis. Japan’s responses to deflation, he charged in atypically blunt terms, were confused, inconsistent and too cautious.Today, Tokyo’s economic problems are more than academic for the Federal Reserve chairman. They are a window into his own situation as he stares at what could be a long period of slow growth, high unemployment and declining inflation in the U.S. There are two lessons from the Japan experience:
1. be aggressive about providing stimulus to the economy in the early stages of a downturn and
2. avoid canceling it too soon.
Click here for the article in the Wall Street Journal. Also an informative interview with columnist Jon Hilsenrath