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Inflation in Japan – Two Decades of Struggling for Bank of Japan

28 July 2020 By Mircea Vasiu

Every central bank in the developed world has a mandate revolving around inflation. Central bankers agreed that inflation levels around 2% are enough to spur economic growth while diminishing the risk of deflation.

However, not all economies are the same. In some parts of the world, like Japan, demographics play an important role, as the aging population is not willing to spend as the younger one does. As such, the Bank of Japan became the most proactive bank in the world, as it applied measures seen as groundbreaking for other central banks’ jurisdictions.

Bank of Japan Measures to Stimulate Inflation 

This week started with the Bank of Japan announcing the inflation level. It merely rose 0.1% on expectations of 0% – basically staying flat, at levels dangerously close to deflation territory. There is plenty of room to go until the 2% target, and the current coronavirus pandemic is making things worse.

The chart above tells the impact of an economic recession to inflation. A close look on the left side of the chart shows how inflation dropped during the Great Financial Crisis of 2008-2009, from over 1% to below -1%.

More precisely, in a couple of years, BOJ saw inflation falling from close to its target to well into deflationary territory. As such, its efforts to bring inflation back to the target were ruined by the global financial crisis started with the American household sector.

From that moment on, BOJ used all its tricks to bring inflation up again – thus, influencing the flows into and out of the local currency, the Japanese Yen (JPY). In 2010 alone, it bought JPY5 trillion in assets, in 2011 expanded the QE by JPY5 trillion in purchasing Japanese Government Bonds (JGBs), and finally, in 2013, started QQE.

QQE, which stands for Qualitative and Quantitative Easing, is meant to expand the monetary policy by JPY60-70 trillion annually. Yet, seven years into the program, and with active Yield Curve Control (YCC) in place since 2016, inflation is nowhere to be found in Japan. 

The current health crisis is yet another blow to BOJ’s efforts to bring inflation close to the target. While the Japanese GDP is not projected to be affected that much as, say, the French or the Italian one, the problem comes from the people’s reluctance to spend.

In other words, it is a lesson to be learned by other central banks too – that no matter the quantity of money pumped into an economy, if the consumer does not spend, reaching the inflation mandate is a tough thing to do.