April 25, 2008 | posted by Michael Baxter in Japan |

Talking of inflation, while in the UK we fret over it, in Japan they want it.   The Japanese economy has been characterised by falling prices – and it was fears that the US could follow in Japan’s footsteps that led the Fed to slash interest to 1 per cent earlier this decade.   And that’s the oddity.     In the West, the Holy Grail, at least for some economists, is how to create growth without inflation.     In Japan the problem has been growth, but not enough inflation.

Whenever we think of the economy of the Rising Sun, we tend to think of permanent sunsets.    Economic performance in the country has been awful – and for Western economists it has taken on a meaning not unlike the role of the bogey man in children’s stories.    Central bankers may wake up in the middle of the night in a cold, cold sweat, because they dreamt of Japan’s lost decade.   

Yet, strangely enough, Japan has actually been expanding for six successive years –  and the growth has even been quite respectable too.  Real GDP grew by 1.5 per cent in 2003, and then 2.7, 1.9, 2.2 and last year 2.3 per cent .

Given this expansion one might be justified in arguing why is Japan hailed as the stuff nightmares are made off.    Well, for one thing, the period before was much worse, so Japan had a lot of catching up to do – so growth should have been better. For another, Japan has this neighbour called China, and you would have expected more of China’s success to rub off on Japan – after all, China accounted for 14.3 per cent of Japan’s exports last year and 20.5 per cent of imports.

A part of the trouble with Japan is that it doesn’t have inflation.    And when consumers expect prices to fall they hold off on their expenditure – they wait until next week when that product they were after might be cheaper.   The Bank of Japan cut interest rates to zero per cent, but actually, in an environment of falling prices, it still paid to save.   

And while in the West money markets were flooded with money leaving Japan via the carry trade, presumably in Japan the problem was the opposite – not enough money coming in.

That’s why Japan needs inflation – not too much, of course, but better some inflation than deflation.

And that brings us back to the theme of the previous article.  Sure, Japan needs inflation, but it has to be the right type of inflation.

Anyone can have inflation at the moment – that’s easy.  With oil and food so high, prices are of course rising.  So there was no surprise, then, when it was revealed that Japan’s core inflation rate has hit 1.2 per cent. 

Before we continue, it is worth pointing out a little Japanese quirk.    In the UK, by core inflation we mean with energy, food and tobacco stripped out.  In Japan, however, when calculating this measure it only strips out fresh foods. So it is a funny kind of core inflation. And many would argue that it is the wrong type of inflation. 

But, and this is the interesting bit – it seems that rising core inflation has led Japanese consumers to expect higher prices. Furthermore, if you dig a little deeper into the inflation figures you find that even after stripping out all food and energy costs, prices still went up on last year. 
 
Okay, the rise on last year was tiny – just 0.1 per cent, but it is the first rise in Japanese inflation after all food and energy since 1998.

So at last then we have good news from Japan.  Many expect the economy to fall into recession this year – it may even already be there, but maybe at last the return of inflation provides scope for a consumer-led recovery. 

It makes a change to say good news, inflation is up – but on this occasion, it appears those sentiments are apt.

There is another lesson too. It appears Japanese underlying inflation is being kick-started by rises in the prices of one-offs.    In Japan that’s good.  But the parallel to the UK is obvious.    It is just in our case the danger is that rising food and oil prices will push underlying inflation too high.

That’s why we are right to fret, and Japan right to celebrate.