A few years ago, various policymakers, but mostly central bankers, were keen to dispel anyone’s idea that they were “doing” Modern Monetary Theory (MMT). Some actively deny it, such as Federal Reserve Chairman Jerome Powell, who declared to the US Senate Banking Committee on February 26, 2019, that MMT was “completely wrong.” Other central bankers and commentators were broadly voiced. No way, they are doing MMT. Well, they are right, one would not “do” MMT because it is an analytical framework (see below). But, oddly enough, commentators are talking to themselves right now, claiming that MMT is dead in the water, as it has tried so far during the pandemic and failed due to runaway inflation. Really funny. But interesting is Japan (as always). I wonder if any of these MMT critics now think about why the BOJ has not followed the lead of other central banks eager to exacerbate temporary inflationary spikes by deliberately creating job losses. In a capitalist monetary economy, policymakers seem to be able to take a different path. They can allow companies to make windfall profits at the expense of workers and then anger workers (causing unemployment), or they can oversee a system where all parties (workers and companies) take a real revenue hit from import price pressures and wait to get out. Japan falls into the second category.
I wrote about this misunderstanding in this blog post about whether to use MMT – False “let’s have a little, some or no MMT” narrative (February 20, 2019).
Regular readers will know that I think Japan is the most worthy economy to study.
From September 2022, I will be working there on a long-term basis under the Japanese Government Scholarship sponsored by Kyoto University.
I hope to be able to release products from that time with my Japanese colleagues in the next few months.
There are many interesting questions to explore, especially the strange case of Japan’s low inflation.
Today, I provide a starting point for understanding this phenomenon.
Why is inflation so low in Japan?
Inflation has risen in almost all countries since supply disruptions caused by the ongoing pandemic began to collide with spending growth sustained in part by government fiscal policy support.
These supply pressures were then exacerbated by price gouging by the OPEC oil cartel, which pushed energy prices to absurd levels.
The subsequent decision by Putin to invade Ukraine put further pressure on supply chains, especially food commodities, and increased demand for non-Russian energy products.
For example, the U.S. all-item CPI has risen 13.3% since January 2020, while the energy component of the U.S. all-item CPI has risen 48.8% and the food component has risen 15.7%.
Excluding food and energy, U.S. CPI is still up 10% since the start of the pandemic.
However, for Japan, the following has happened since January 2020:
1. All items – up 1.3%.
2. Energy – up 14.6%.
3. Food – up 3.2%.
4. All items minus food and energy – actually down 0.01%.
The American experience is mirrored around the world, making the Japanese experience unusual.
The chart below tells the story that must be explained.
The first graph is the annual inflation rate for all items in Japan and the US (indexed at 100 as of January 2020).
Pre-pandemic – the two indices were more or less in lockstep.
But starting in mid-2020, the difference is startling.
The chart below shows the energy content in each CPI.
Both countries have similar stories.
The chart below shows the food composition – again a divergence.
So why is Japan able to avoid high inflation in the rest of the world when both countries experience energy price shocks in similar fashion?
The first thing to note is that producer prices in Japan follow global trends.
Bank of Japan production – producer price index – Monthly, latest version May 2022 – Corporate Commodity Price Index Monthly Report – Shows that the index rose 9.8% in the year to May 2022.
The import price index rose by 42.2% (in yen) over the same period.
The chart below is taken from the latest data released by the Bank of Japan:
As a result, local producer input prices are largely driven by rising import prices – energy and timber being the most prominent of these imports.
Second, the dramatic drop in communication costs is a factor.
Further analysis of the CPI subgroup showed that the communications component index fell from 99.9 points in January 2020 to 66.2 points in May 2022.
Why is there such a dramatic drop in communication costs?
The central government has been pressuring telecom operators to lower the cost of mobile phones for consumers, which has led to a drop in charges of almost 34%.
Japan’s communications minister said in October 2020 that they would reduce mobile phone charges (resource):
…with a sense of urgency…we believe this will bring charges more in line with international standards.
The campaign to persuade/press telcos works well.
However, the relatively low weight of the communication component in the overall index means that other explanations are needed.
There are several salient features that explain why Japan has resisted soaring inflation despite enormous import cost pressures.
First, there is no wage pressure, which is not really a differentiating factor because no country has really experienced any significant real wage resistance from workers anyway.
Second, Japanese companies have significantly different attitudes towards passing on.
In the U.S. and elsewhere, companies with pricing power don’t hesitate to push rising unit costs onto consumers as they defend their real profit margins.
In the 1970s, when unions were stronger, this market force gave rise to real wage resistance and price-wage spirals, as workers retaliated against real wage cuts by pushing nominal wage increases.
Now, unions are weak, and workers are forced to accept real income cuts to bear the burden of rising import prices.
In Japan, companies are paying more attention to their reputation and have clearly refused to pass on rising import costs.
That’s partly because fiscal moves have helped them absorb cost pressures (see below), but overall, the corporate mentality is different.
It doesn’t make sense whether to label price gouging by US and other companies. The truth is that these companies don’t absorb cost pressures into their margins, which Japanese companies are apparently doing (with notable exceptions).
But it doesn’t all depend on the socially conscious behavior of Japanese companies.
In the absence of wage pressures, real growth in spending is suppressed, to say the least.
The chart below shows the total major spend from the March 2015 quarter to the March 2022 quarter.
Real GDP remains 1% below pre-pandemic levels, and household consumption spending is 1.5% below.
Private nonresidential investment is 6.9% below pre-pandemic levels, and the gap is widening.
Therefore, it can be said that the product market environment is very weak, which is not conducive to companies driving up prices because they are worried about losing market share.
In the US, for example, the product market is stronger and companies have more room to pass on price increases.
Interesting fact, though, that Japan’s unemployment rate continues to fall, at 2.6% by May 2022, well below the level in most countries.
We often hear Anglo commentators talk about Japan’s low growth (“lost decades”) in derogatory terms, but they fail to mention that Japan has consistently outperformed the world in unemployment.
If a country still has low unemployment (and public services are good), it doesn’t need strong growth.
The point here is that the Anglo countries (and Europe followed closely) are interested in creating a “soft” product market through monetary policy rate hikes.
They believe this will curb inflationary pressures and, to some extent, keep companies from passing on rising costs.
This disincentive will be relatively weak at first, before companies start to go bankrupt in large numbers.
But unlike Japan, which has a much lower growth trajectory than the U.S., the Fed’s approach will only work (if at all) by substantially increasing unemployment on a massive scale.
Japan will ride out a brief rise in import prices without resorting to a devastating increase in unemployment.
While fiscal and monetary policy is now tightening almost everywhere, the situation is markedly different in Japan – which I’ll touch on next.
Back to the Bank of Japan and the Ministry of Finance at the same time
Life goes on without the compulsive panic faced by commentators in our other governments trying to put pressure on them to eliminate inflation by increasing unemployment and dampening demand.
The Bank of Japan continued to set the yield on 10-year government bonds to zero through its daily bond-buying program.
The bank has accepted some depreciation in the yen due to the growing disparity between US (and other countries) interest rates and the zero interest rate policy being implemented in Japan.
The central bank has clearly not fallen into the trap of many other central banks – rejecting the notion that raising interest rates will dampen inflationary pressures without causing a significant increase in unemployment.
It understands that once these temporary import price pressures are absorbed, inflationary pressures will quickly subside.
This is still my opinion.
Fiscal policy in Japan is also being adjusted in response to what they see as temporary cost-of-living pressures.
On April 21, 2022, the government announced a “supplementary” fiscal package aimed at supporting low-income households and small businesses struggling with rising import prices.
This document (17 May 2022) – FY 2022 Supplementary Budget Overview – Detail the stimulus measures the government will roll out, totaling 2,700.9 billion yen.
Very exciting.
1. 1,173.9 billion to resolve the surge in crude oil prices.
2. 1,520 billion yuan will be used for contingency expenses for future oil price rises.
The injections include a one-time cash grant of 50,000 yen per child in low-income households, and subsidies to gasoline wholesalers to help them control the pass-through to consumer prices.
The government has also said it prefers to address these issues through direct action by fiscal policy, rather than trying to raise interest rates or manipulate the yen.
You can be sure that they also don’t deliberately create a rise in unemployment in response to inflationary pressures.
This really sets Japan apart from the English-speaking West.
The Anglo countries have indeed lost respect for the continuity of employment and workers.
in conclusion
I’ll be writing more about Japan in the next few months.
Enough for today!
(c) Copyright 2022 William Mitchell. all rights reserved.
