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Friday, March 21, 2003

What Type of Deflation in Japan?

Morgan Stanley's Takehiro Sato draws our attention to a debate in Japan that is not without importance. The debate became public through the delcarations of BoJ Policy Board member Kazuo Ueda in an opinion article that appeared in the Nikkei Shimbun on March 17. In the piece he questions the Bank’s official stance toward the Non Performing Loan (NPL) problem. He draws a clear distinction between asset price deflation (particularly that of land and property, which has fallen some 70-80% since its peak) and the consumer price index, which has fallen rather moderately. The asset price decline is what bears comparison to the 1903's deflation problem, but the slow-burn chronic deflation reflected in the CPI is, in my book, something new and decidedly modern. This argument remains unchanged even if poor measurement practices mean the decline in the CPI has been slightly larger than estimated. The property angle is worthy of much deeper investigation for it's importance in the spectacular growth of the Japanese economy, and because with an ageing and shrinking population pressure on Japan property values are likely to decline and not increase. Again how to resolve the structural problem of the major outstanding policy problems facing Japan. All in all, the argument is an important one since it relates to whether or not monetary solutions can work in the absence of a complete restructuring of the banking system.

According to Ueda, asset price deflation, not general price deflation, is linked closely to the Japanese economy’s current stagnation and macro policies that work against general price deflation are unlikely to lead to a sustained recovery. Reasons given to support this view are (1) no indication of a rise in real debtor burden caused by higher real interest rates, as occurred in the 1930s, given the mild 3% cumulative decline in the CPI from its peak, (2) no evidence of general price deflation leading to asset price deflation with almost no correlation between asset price and general price trends, considering the 70-80% cumulative decline in the urban land price index from its peak, tantamount to asset deflation during the Great Depression, and (3), conversely, some downward pressure on general prices from the inability to resolve quickly setbacks to the financial intermediation function caused by asset price deflation.

Based on these assumptions, efforts to boost general prices using macro policy would not provide a solution for asset price deflation. This position blunts the arguments of those calling for inflation targets through the purchase of risk assets. Ueda also projects a continuation of negative pressure on asset prices until the Japanese economy succeeds with structural transformation and asserts that this is a necessary adjustment. It is hence necessary to revitalize the financial intermediation function along with macro policies to stop general price deflation in order to limit adverse repercussions from a debt-deflation-adjustment process comparable to the 1930s. There must be a restructuring of both borrowers and lenders and a rebuilding of the financial system using public capital where appropriate. However, Ueda’s view puts asset price deflation at the center of the NPL problem and differs in nuance from the Bank’s official stance presented last October in the areas cited below.
Source: Morgan Stanley Global Economic Forum

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