Economic Challenges in the West
As the western world navigates through uncertain economic times, many are calling on the Federal Reserve to intervene and prevent a recession. However, the experiences of other countries, such as Japan, demonstrate that central banks have limited capabilities in addressing economic issues. In fact, Japan’s recent struggles with inflation highlight the potential consequences of relying on central banks to stimulate the economy.
Japan’s Inflation Surge
According to recent reports, Japan’s consumer prices rose by 3.4 percent in May, down slightly from the 3.6 percent increase in April. This surge in inflation is a significant change from Japan’s typical economic trends, as the country has often struggled with deflation since the 1990s. The current inflation rates are the highest Japan has seen in decades, with the core inflation measure also experiencing a substantial increase.
Causes of Inflation
The Bank of Japan (BOJ) has been pursuing a negative-interest-rate policy since 2016, holding its policy rate at -0.1 percent for 97 months. This move was intended to stimulate the economy through standard Keynesian-style measures. However, the BOJ also had to intervene in the management of Japanese sovereign debt prices, as the government is heavily indebted. As a result, the BOJ has amassed a large portfolio of government debt, holding over 50 percent of the total.
Consequences of Monetary Inflation
The BOJ’s actions have led to the creation of new money, resulting in monetary inflation. This inflation began to manifest in a significant way following years of aggressive COVID-19-related spending. By mid-2022, consumer prices in Japan started to rise rapidly, increasing from 0.1 percent in October 2021 to 3.8 percent in October 2022.
Global Context
In a global context, Japan’s inflation surge is relatively moderate. However, in the context of Japanese prices, the increase is substantial. Japan’s CPI inflation has remained high, tied with the UK’s rate at 3.4 percent, while the US and euro area have lower rates at 2.4 percent and 1.9 percent, respectively.
The Political Price of Price Inflation
The rising inflation has led to sluggish wage growth in Japan, with real wages falling for four consecutive months. This has proven to be politically unpopular, forcing the BOJ to allow its target policy interest rate to rise above zero to 0.1 percent in April 2024. The rate was further increased to 0.5 percent earlier this year.
Attempts to Rein in Inflation
The BOJ has also started to shrink its enormous portfolio of Japanese government bonds, adopting a policy of reducing its portfolio by 200 billion yen ($2.7 billion) per quarter. As a result, yields have risen to some of the highest levels seen in over 15 years, imposing larger debt obligations on the government.
The Limits of Easy-Money Policy
Japan’s experiences demonstrate that inflationary monetary policy is limited by political realities. Eventually, the negative consequences of inflation, such as falling real wages and a declining standard of living, will become problematic for governments. Central banks are then forced to rein in monetary inflation, leading to rising yields and potential sovereign debt crises.
Conclusion
The story of Japan’s economic struggles serves as a cautionary tale for the western world. The limits of easy-money policy and the potential consequences of relying on central banks to stimulate the economy are clear. The only long-term solution to these issues is genuine fiscal austerity and debt repudiation. As the world navigates through uncertain economic times, it is essential to consider the lessons learned from Japan’s experiences and strive for more sustainable economic policies.
