Use tables or graphs to illustrate the price stability performance of Japan Essay Example

Use tables or graphs to illustrate the price stability performance of Japan Essay Japans economic slump, which began with a stock market crash in 1989, now lies in its fourth recession in ten years. The Asian banking and financial crisis has had a profound effect on this, the second largest economy in the world. Japanese under performing banks are carrying Yen150 trillion ($1.3 trillion) of bad loans. State-run corporations are dragging productivity down, unemployment is rising and Japanese consumer confidence remains low. Macroeconomic policy is proving highly unstable as Japans illness that of deflation remains predominant. Price stability is defined as the sustained absence of both inflation and deflation. (Mc Aleese: p.294, 2001). Further economic agents can make decisions regarding economic activity without being concerned about the fluctuation of the general price level. Along with effective fiscal policy, the control of government spending, low unemployment levels, controlled interest rates and hence inflation rates, macroeconomic policy is maintained. The most serious aspect of Japans economic sickness is deflation. Japans paralysis, where ineffective control measures have had many negative results, will now be discussed. Price Stability: We will write a custom essay sample on Use tables or graphs to illustrate the price stability performance of Japan specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Use tables or graphs to illustrate the price stability performance of Japan specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Use tables or graphs to illustrate the price stability performance of Japan specifically for you FOR ONLY $16.38 $13.9/page Hire Writer Price stability, or rather instability in Japans case, is characterised by the prolonged presence of deflation. The stock market is hovering around a 19 year low. The Nikkei 225, the most commonly used Share Price Index, had stood at 14 times the Dow through the 1980s. However in February 2002 it dropped below the Dow Jones Industrial for the first time since 1957. Japans persistent decline in the general price level is again indicated by the Consumer Price Index. Prices have shown a 1% fall per annum. These falling price levels have increased real debt burdens. National debt stands at over 130% of GDP (www.economist.com). Also Japans banks are chronically weak and burdened by duff loans of Yen37 trillion, about 7% of GDP. So Japanese banks have been left carrying excess bad loans, forcing them to cut lending. Together with depressed consumer spending it has proved impossible for the Bank of Japan to deliver the negative real interest rates that the economy needs to revive demand. Interest rates in Japan stand at virtually 0%. However most companies are not investing but paying down their debts (mentioned above). This adverse impact on investment is also due to the fact that real long-term interest rates in Japan have reached high percentages. The fact that interest rates stand at zero has kept inefficient firms afloat and delayed restructuring. This has contradicted Japans bust advantage. Structural adjustment and creative destruction can prove positive outcomes of negative fluctuations. However, rigid labour and product markets, along with the Japanese keiretsu relationship have hindered the weeding out of inefficient firms. Simultaneously, low interest rates have led to low inflation rates (-0.6% in 2001). This has reflected weak demand and thus the economic slowdown. These supply-side factors, such as the intensification of global competition and deregulation, have put additional downward pressure on prices. This is contributing to the high debt ratio and subsequent price destruction. This bout of recession and deflation has not only had negative impact on CPI, share prices, investment and inflation but also on property prices. Since 1991, commercial property prices have dropped by an average of 84% in Japans six biggest cities (www.economist.com). Housing demand has also collapsed since 1996. Analysis: It remains evident that Japans economy lies in uncertainty, where consistent unstable price performance has given rise to the lost decade. Its current situation comprises of internal factors (e.g. buyer uncertainty) and external factors (e.g. the U.S. current bubble burst). These counter-cyclical variables have had the following negative effect the decrease in economic activity in Japan has led to the increased unemployment rate (+5.3%), bankruptcies, non-performance loans etc. Analysing Japans current prolonged crisis, it becomes evident that it displays attributes of Keynesian economics. The existing shifts in aggregate demand, the low rate of investment and price rigidities, all clearly display this. Price stability is an indispensable prerequisite to ensure sustainable development of the economy (Masaru Hayami, Governor Bank of Japan). 77 year-old Mr. Hayami however has failed so far to deliver such a position. This political paralysis, where political resistance to reform is demonstrated, is hindering Japans recovery. Again, the current Japanese Prime Minister, Junichiro Koizumi (elected April 2001), who unveiled a series of economic reforms has met with little success against this rigid political system, resistant to reform. Furthermore his termination of Makiko Tanaka (his Foreign Minister) in January 2002, along with his lack of co-operation with Economics Minister, Heizo Takenaka, has left Japan still in search of a cure. Is there Evidence of Inflation or Deflation in Japan at the moment? What problems might be associated with very low inflation or deflation? Deflation is defined as the persistent decline in the general price level of goods and services1. The most common measure of inflation statistics is the Consumer Price Index (CPI). In Japan, this has fallen at a rate of about 1% since 1999. If the GDP Deflator is used this deflationary trend can be traced back to 1995. The difference between potential and actual GDP is called the output gap. This is another indicator of price stability (or instability). Price stability is defined as the sustained absence of deflation (falling prices) and inflation (rising prices). It is fundamental to the second pillar of the new consensus, macroeconomic stability. Therefore policy makers welcome disinflation and low inflation. Owing to the bias2 in constructing CPI indices, an inflation rate of 0-2% has become acceptable. There are certain costs of changing prices regardless of whether these are due to high inflation or deflation. There is a loss in efficiency as menu costs and shoe leather costs are incurred. Additionally, the necessary fiscal and monetary policies required to attain stability are costly. More specifically, why is deflation problematic? Initially, falling prices seem like a good thing and people feel as if they have more money in their pockets to spend. Even those on a fixed income, (state pensions, social welfare) benefit from an increase in real income. In spite of all this, the far-reaching contagion effects of deflation mean it is a phenomenon to be avoided. Rather than spending more on the goods, which they can now afford, a continuous fall in prices means that consumer and investor spending actually slows down. Consumers and businesses are reluctant to buy goods, which they expect to drop in value in the near future. Such speculation curbs investment and saving increases. In an effort to encourage borrowing for investment, nominal interest rates fall and approach zero. Since the nominal interest rate is the opportunity cost of holding money, savings further increase. This fall in investment demand and activity retards economic growth. Furthermore, since the nominal interest rate cannot fall below zero, the real interest rate will always be positive. In times of deflation, the burden of debt therefore increases. It would seem that lenders gain and borrowers lose. The problem for lenders occurs when debt rises too high and borrowers cannot afford repayments. Banks who earn profits through loan repayments cannot attract big borrowers. T his type of debt deflation is the main problem in the Japanese economy today but is also reminiscent of the Great Depression in the 1930s. In times of low economic growth, it is typical to lower the currency value thereby making exports more attractive to foreign investors. However, the low nominal interest rates induced by deflation have caused foreign demand for the Yen to rise. The Yen remains strong and exports remain relatively expensive. On the whole, wages are accepted to be ratchet. This means that even if prices are falling, the nominal wage rate will not fall. Higher debt repayments and squeezed profits mean that the pressure on companies to cut costs is twofold. This leads to a Darwinian shake-out as companies see job cuts as the only option to save on costs. Deflation is clearly at the root of Japans failing economy. Policy makers must now look to the formulation and implementation of an effective plan to fight deflation if there is any hope of a recovery.