JAPAN DEFLATAION

Deflation in JAPAN

The Japanese economic expansion in 1989 startled and awed the globe, but did the
economy of this Asian archipelago, which came so close to overtaking America as the
world's number one economic powerhouse, end in deflation and stagnation?

It has become so bad that the Bank of Japan has bought up to 70% of government debt and
is now the largest shareholder in Japanese corporations.

Causes for the Deflation

Overconfidence and the Bank of Japan's lax monetary policy

Aggressive speculation in domestic equities and real estate fuelled by the mid-to-late 1980s
drove prices to previously unimaginable heights. Between 1985 and 1989, the Nikkei stock
index in Japan quadrupled to 39,000 points.

Japanese policymakers were becoming more concerned about the country's developing
asset bubbles by 1989, forcing the Bank of Japan to tighten its monetary policies. The Nikkei
stock market bubble broke shortly after, and the Nikkei dropped nearly 50% from around
39,000 to 20,000 in 1990, finally reaching 15,000 in 1992. Japan's stock bubble burst,
causing the

country's real estate bubble to bust as well, throwing the country into a devastating
financial catastrophe.
The American - Japanese trade war 1979-1990

Japan, whose industries appeared to be unstoppable, so much so that the United States
thought Japan might supplant them as the world's leading economic power. So, starting in
1981, the United States limited the quantity of cars that could be imported from Japan each
year. Then, in 1983, they put a 45 percent tariff on Japanese motorcycles, ostensibly to
safeguard the American motorbike icon, Harley Davidson.

Furthermore, the Bank of Japan agreed to sell large amounts of its dollar reserves in order
to boost the yen while weakening the dollar.

The Bank of Japan dropped interest rates considerably lower to fight the Yen's rising trend.
Borrowing became much more accessible as a result, setting the groundwork for one of the
largest national bubbles in history.

The Japanese economy shifted from miracle economy to stagnation and deflation at this
period.

Debt deflation 1990

Japan's economy stagnated after the stock market and housing booms erupted in the 1990s.
Companies are concentrating on debt reduction and relocating manufacturing. Wages have
stayed flat, and consumers have cut back on their purchases.

Because of the drop in property values, most people are now stuck with a large debt as well
as a home that is significantly undervalued. This home can no longer be sold to fully repay
the loan. As a consequence, if individuals want to move, they'll have to pay back their debts
the old-fashioned way: by tightening their belt buckles and buying fewer things. As a result,
total demand for goods will inevitably decline. The supply of commodities, on the other
hand, stays constant. After all, the factories are still open for business, and there are plenty
of job seekers. As a result, because the whole supply of something exceeds the total
demand for it, the average price of that item declined, resulting in deflation.

Incomes plummeted even further, debt repayment became much more onerous, and
deflation set in. To break the cycle, central banks will have to move quickly. Debt deflation
had set in, and prices continued to decline throughout the 1990s, despite the Bank of
Japan's delayed and futile attempts to break the vicious cycle.

Once deflation set in, consumers began to anticipate price cuts and postponed purchases as
long as possible in order to save money. This aggravated the condition and kept the loop
going.

The inflation expectations Trap: the 2000s

The global financial crisis struck, and Japan was particularly heavily hit. Even though the
financial crisis began in the United States, Japan's GDP contracted more than the United
States'.

However, the difficulty was that Japan was strongly reliant on exports, notably automotive
exports, and when demand in Europe and the United States fell, these sectors suffered
greatly.

This was a setback for the Bank of Japan, which was still desperately seeking to raise
inflation expectations. As a result, Japan concluded yet another decade in recession and
deflation. This time, the recession was caused by overseas issues.

Population decline

Japan's population is rapidly declining. Japan's ageing population is exacerbating the

problem. It is anticipated that Japan would lose roughly 600,000 people each year by 2020.
It is difficult to generate growth in an ageing, diminishing society.

After all, fewer people working implies lower wage income and lower demand for goods,
and with greater technology to replace workers who now receive pensions, it's no surprise
that deflation has been so difficult to overcome.

EFFECTS OF THE DEFLATION

Real wage unemployment-'Sticky wages' are common in labour markets. Workers are
resistant to nominal wage cuts (no one likes to see their wages lowered, especially if they
are used to annual raises). As a result, during periods of deflation, real wages grow.

Discourages consumer spending-When costs are falling, it often encourages people to

postpone purchases because they will be cheaper later. It may deter buyers from purchasing
luxury products or non-essential items, such as a flat-screen television, because they could
save money by waiting for it to become cheaper.
Increase real value of debt-Deflation makes it more difficult for borrowers to repay their
obligations. As a result, consumers and businesses must devote a greater proportion of their
discretionary income to debt repayment.

Increased real interest rates- Interest rates are not allowed to fall below zero. If there is a
2% deflation, this means we have a 2% real interest rate. Saving money, in other words,
yields an acceptable return. As a result, deflation may contribute to an unwelcome
tightening of monetary policy.

More difficult for relative prices and wages to adjust-If average prices or wages rise by 3%,
it is easier for some goods to rise by 0% and others to climb by 6%. With zero percent
inflation, it is more difficult to obtain this relative shift in prices or salaries.

Deflation can become entrenched and difficult to end-Japan's experience in the late 1990s
and early 2000s was that once deflation became the new normal, changing inflation
expectations and resuming normal growth was extremely difficult.

MEASURES

Abenomics

Prime Minister Shinzo Abe's economic programme is referred as Abenomics which came
into existence in 2012 promising of sweeping economic reforms

They are based on exceptional monetary easing, government spending, and deregulation of
the commercial sector.

The Prime Minister refers to it as his "three-arrow" plan, a reference to a Japanese folk tale
that teaches that three sticks together are more difficult to break than one.
The first arrow pointed to monetary policy-which meant essentially a continuation of the
past but escalated to the extreme. This meant that the Bank of Japan would begin
purchasing more short-term government debt, long-term government debt, corporate debt,
and would also join the stock market. This meant that the Bank of Japan would begin
purchasing more short-term government debt, long-term government debt, corporate debt,
but also, and this was truly unique to Japan, join the stock market.

Second arrow of Abenomics - Increased government spending

Shinzo Abe unveiled a slew of expenditure packages. Under his leadership, Japanese
government debt approached a startling 240 percent of GDP, becoming the Japanese
government the world's most indebted.

Third arrow is structural reforms-

 Allowing more shareholder activism to promote corporate rivalry

 Corporate tax cuts
 Corporate deregulation
 A slew of corporate trade accords.