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In 2009, the global financial crisis caused Japan to return to deflation again, the first time since 2006. While deflation benefits providers of low-priced goods and necessities, it is negative on consumer spending, business profitability and investment, as well as employment and household income.

  • The Consumer Price Index (CPI), which measures the average price movements of goods and services purchased by Japanese households, was 99.3 in February 2010 (2005 = 100), down from 99.4 in the previous month and 100.4 a year earlier;
  • Since 1995, Japan has a history of struggling with deflation. The 1990s is often referred to the ‘lost decade’ for its struggle with falling prices. The major reason is the bursting of asset bubbles in the equities and real estate markets in the 1990s, which shrank money supply as assets decreased in value;
  • Another reason is regional economic integration, whereby the imports of cheap consumer goods and raw materials from other regional countries depress domestic prices in Japan.
Annual inflation rates in Japan: 1990 – 2010
Annual % change

Source: Euromonitor International from IMF /UN/national statisticsNote: Data for 2010 is forecast.

Implications

  • With declining prices, prospects for long-term consumer demand growth remain low. Consumer spending, which accounts for more than half of the economy, is delayed as goods are expected to become cheaper. This reduces corporate earnings and limits ability of retailers to expand and employ people. With fear of job losses and limited spending power, cost-conscious consumers seek low-priced goods or goods of reasonable price to quality ratio, such as private labels products;
  • Deflation affected non-grocery retailing more than grocery retailing. While consumers need to buy necessities, they were put off purchasing large-ticket items in expectation of cheaper prices in the near future. In 2009, non-grocery retailing fell by 4.7% in real terms, while grocery retailing dropped by 1.9% in real terms;
Annual real retailing growth in Japan: 2000 – 2009
Annual % change

Source: Euromonitor from trade sources/national statisticsNote: Growth rates are based on retailing value at retail selling prices, excluding sales tax.

  • Meanwhile, due to deflationary expectations, interest rates that can be earned from long-term loans for banks remain very low. This prevents banks from profiting from the difference between short- and long-term interest rates in normal conditions. As a result, the lending environment remains weak;
  • Companies are thus faced with multiple challenges. Firstly, weak consumer demand due to falling prices squeezes out profits. Secondly, weak lending from banks forces companies to pay down debts instead of proceeding with new investment projects. While export-oriented companies are able to benefit from foreign consumer markets, firms relying on the domestic markets suffer from decline in profitability and investment;
  • This downward spiral feeds back to households. As domestic firms cut back, their ability to create new jobs reduces whilst existing employees suffer from pay cuts. In 2009, wages on average were 10% lower than 1997 levels. Insecurity of household income does not only dampen consumer expenditure, but also discourages people from having children, further exacerbating the ageing demographics of Japan, where about 20% of the population are over 65 years old.

Prospects

  • During 2010-11, policy makers are expected to continue with fiscal policies that boost demand and bank lending. These include Tokyo’s cash-for-clunkers and eco-points programmes to boost household spending as well as the expansion of the Bank of Japan’s short-term low-rate loan facility to commercial lenders;
  • However, there are concerns that monetary policy alone cannot cure the problem of deflation. As the effects of the stimulus fade, huge public debts (at 180.4% of GDP in 2009) limit the government’s ability to sustain the economy, and BOJ has exhausted its conventional policy options, deflationary pressures are expected to remain. In 2010, annual inflation rate is projected at -0.9%;
  • Without new stimulus measures, any future improvements can only depend on an economic recovery. Japan’s real GDP growth is forecast at 1.7% in 2010, up from -5.2% in 2009.
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