Is Japan’s Inflation Really At a 40-Year High?
What, if anything, does it mean for BOJ Policy?
Source: Statistic Bureau at https://www.e-stat.go.jp/en/stat-search/file-download?statInfId=000032103932&fileKind=1
“October Inflation At A 40-Year High” read the headlines. If this really were representative of overall inflation trends, it would put additional pressure on the Bank of Japan (BOJ) to raise interest rates in order to slow an overheating economy. But it reminds me of the line from the movie Absence of Malice: accurate but not true.
For one thing, this figure refers to the Bank of Japan’s traditional measure of “core” inflation, which comprises all items except fresh food. However, if we use other countries’ measures—all items except energy and all food—then core inflation is at less than half that pace: 1.5% (see the comparison in the chart above). Core inflation is meant to show long-term trends by stripping out items whose prices gyrate up and down a great deal in response to relatively small changes in supply and demand, import prices, etc. The BOJ’s measure of the core, however, includes such items.
Secondly, such year-to-year comparisons can sometimes be misleading when applied to products with price volatility. A dip in prices in one year before may lead to the appearance of a big rise in the following year, when all that is happening is getting back to a previous level. For example, the price of all items except for all food and energy is no higher today than it was almost three years ago in January 2020. Consequently, even the 1.5% year-on-year comparison for the latter measure of core inflation gives a false impression of the underlying trend and is not, therefore, a reliable harbinger of the future (see chart below).
Source: Statistics Bureau at https://www.e-stat.go.jp/en/stat-search/files?page=1&layout=datalist&toukei=00200573&tstat=000001084976&cycle=0&tclass1=000001085995&tclass2=000001085936&tclass3=000001085996&tclass4=000001085976&tclass5val=0
Nothing has changed from the previous situation: virtually all of Japan’s inflation in the past three years is due to price hikes in import-dominated items: food, energy, clothing, and footwear. Prices of the latter are rising partly due to higher inflation rates overseas and partly due to the weakening of the yen, which raises the price of imports in yen terms. The rest of the consumer basket has shown virtually no hike in prices (see chart below).
It’s certainly possible that, if imported inflation continues long enough, inflation could spread throughout the economy. So far, however, that has not happened. Hence, nothing in the latest data is likely to provoke any change in the BOJ’s monetary stance.
The BOJ has been counting on wage hikes induced by a labor shortage to lead to healthy, domestically-created inflation of 2%, realizing that monetary policy alone cannot achieve its 2% inflation goal. It is said to believe that the reason is that, with more women and retirees entering the labor force, the shortage was not as great as superficial statistics seemed to show. Now, the BOJ is cautiously hopeful that the tide has turned, and points to the demand by the chief labor union federation, Rengo, for a 5% wage hike in next year’s “spring offensive” at the large companies. That is its largest request in 28 years and is, in part, a response to current inflation. However, Rengo is not likely to succeed. Keep in mind that it has asked for 4% each year since 2016 and failed to come close. Moreover, even if Rengo succeeded, this would help only a small share of the workforce. Finally, with the US and Europe expected to suffer recessions, even cash-rich companies will resist such a large hike.
One final note. A reader of this post wrote to me: “Do you go food shopping in Japan? This statistical nuance has little to do with not just the perceptions of ordinary people, but with the ability of many people in all but the wealthiest classes to feed themselves — particularly the elderly and the working poor…This sort of argument is rather detached from real life.”
Here is my answer: I take this point and agree with it. The measure of inflation that you use depends on what you are trying to measure. If you are trying to measure the pain to the population, including real, i.e. price-adjusted income, then you measure total inflation. If, however, you are trying to measure underlying trends to see how long inflation is going to stay high, then you need to eliminate highly volatile items. Otherwise, you might think inflation is too high and slow the economy unnecessarily, or you might think it's too low and add stimulus which could worsen inflation down the road.
You also want to know the cause of inflation. If inflation is caused by excess domestic demand, then raising interest rates could help by slowing the economy and reducing the excess demand. If your inflation is mostly imported, raising interest rates will further slow down an already weakened economy.
Finally, while inflation causes pain, so does the cure for inflation: higher interest rates that raise unemployment. Judging what's the best trade-off at any given level of inflation in a world of uncertainty is not easy.
Raising interest rates is not necessarily bad for the economy. It can make zombie companies go bankrupt and incentivize firms and economies to be more productive and grow.
Very good points, Richard, also in the commentary below