Author: Gerhard van Niekerk
There is a widely circulated quip of unknown origin in the field of macroeconomics that generalises the world economy as follows: “Throughout history there have been only four kinds of economies in the world: advanced, developing, Japan, and Argentina.”[1] Japan is one of the only economies where wages and the prices of goods have remained stable for nearly three decades, and where any alterations to these prices are seen as highly taboo. Japan’s central bank, the Bank of Japan (BOJ), recently raised interest rates for the first time in seventeen years, sparking some inflation and breaking this trend of stable prices.[2] This marks a major shift in economic thinking by Japan’s policymakers and is a highly significant move to reform the country’s economic growth strategy. What does this mean for the Japanese economy? This article investigates the BOJ’s plans to use inflation to encourage consumer spending and investment in order to achieve stronger economic growth.
Before discussing the new policies, a historical overview of the BOJ and the Japanese government’s monetary and fiscal policies is needed to understand what brings us to this moment. Japan’s post-WWII economic experience can be divided into two broad eras: Firstly, the Japanese Economic Miracle (Kōdo keizai seichō) from 1945 to the early 1990s; and secondly, the Lost Decades, of which the timeline is debated, but most agree that it spans from the early 1990s to the 2010s (Ushinawareta 30-nen).[3]
The postwar economic miracle that Japan experienced after the destruction caused by WWII was nothing short of breathtaking. The United States (US) occupation of Japan (1945-1952) saw major structural changes to the Japanese government and economy as the US sought to entrench liberal internationalist values in the Japanese administration. Japan was therefore viewed as a suitable future partner for the US and was seen as an important ally to US presence in the Asia-Pacific.[4]
From 1960 to 1990, Japan achieved a mean yearly GDP growth rate of 6.21%.[5] It is argued that this tremendous rate of economic expansion would not have been possible without the assistance of the omnipresent reach and power of the US during the Cold War. Specifically, the US tolerated some oft-criticised trade practices, it absorbed a large proportion of Japan’s exports, subsidised certain industries and played a role in technological progression.[6]
By the mid-1990s, Japan was the second largest economy in the world and even rivalled the US.[7] However, all was not well in the Japanese economy. It faced two significant hurdles with the 1973 and 1979 oil shocks, which negatively impacted Japan’s rate of industrial expansion due to the higher oil costs.[8] Moreover, the US economy had burnt out due to its role in supporting France, Germany, Italy and Japan’s respective postwar revivals; each of which had developed formidable economies at the time. The US called its allies to the Plaza Accords of 1985, at which it was agreed that the US dollar would be devalued and the trade deficit held by each respective state would be decreased.[9]
Japan’s internal approach to these international crises was far-reaching. In response to the oil crises, the BOJ slashed interest rates in order to maintain a steady rate of consumer spending and investment. At first, Japan’s economy appeared healthy and made strides in science and technology due to the resultant increases in investment. After the Plaza Accords, the Japanese yen appreciated significantly, resulting in even more domestic spending due to cheaper imports. In addition, the BOJ decided to lower interest rates even further to alleviate much of the upward pressure on the yen. This set the scene for a major asset bubble, that is, a rapid rise in the price of assets, usually resulting from unrestrictive monetary policies. A major criticism against the BOJ at the time was its unwillingness to restrict lending to cool down the economy for the sake of more sustainable growth.[10]
The asset bubble had grown so significantly that the estimated value of the Kyoto Palace in 1987 was more than the total real estate value of the US state of California.[11] The BOJ was well-aware of the risks attached to a bubble economy, but it is thought that these risks were underestimated at the time due to the rapid growth of the economy and the wealth Japanese citizens accrued from this growth. In 1989, the BOJ decided to raise interest rates from 2.5% to 4.25% and introduced a consumption tax. The yen fell against the US dollar, but the Nikkei Stock Average and land prices remained relatively stable. However, in 1990, the BOJ raised interest rates to 6%, and by 1991, the Nikkei Stock Average nearly halved its value and property prices in Tokyo crashed.[12] By early 1992, the bubble collapse had been officially declared, marking the start of the “Lost Decades” theme in Japanese economic history.
The BOJ was confronted with numerous obstacles to economic growth in the 1990s; public debt and unemployment were at record levels; consumer confidence was at record lows, and there was an oversupply of goods as a hangover from the overheated economy. What followed was a cycle of debt-deflation, where prices and wages fell continually, making debts progressively more difficult to pay.[13] In order to curb the effects of lower spending, the BOJ kept injecting significant amounts of funds into the economy and slashed interest rates. By 1999, the BOJ introduced a zero-interest rate policy, where the rate had been zero, slightly negative, or near zero for over two decades.[14] As an additional means of stimulating the economy, the government consistently ran budget deficits, which has left Japan with the largest debt to GDP ratio in the world at 261% in 2023.[15]
The Japanese government’s fiscal and monetary policies have faltered in their attempt to stimulate growth and consumer spending. Since the zero-interest rate policy was adopted, Japan achieved 0.65% year-on-year economic growth (1990-2022).[16] After 1998, businesses became net savers, opting not to borrow in order to repay their debts and this led to a significant drop in corporate investment. The BOJ made up for the shortfall by becoming the biggest spender in the economy, and essentially stabilised Japan’s GDP. This is called a “balance sheet recession”.[17] This critically led to a situation of stagnant wages, which have increased sluggishly since the late 1990s. Wages for men have essentially remained stable, while overall wages and wages for women have increased slightly due to more women entering the workforce.[18]
This is a strange arrangement for most, as increased wages and prices of goods on yearly bases are expected in nearly every other country on the globe. Cultural factors, in combination with the prevailing economic climate, have resulted in a fascinating culture of price stability where the value of the yen is broadly viewed as unchanging. Japan’s GDP per capita and the price of goods stagnated since the 1990s and this has led to a situation where consumers expect certain items to remain at the same price they have been for decades. For example, when the price of a popular Japanese snack, umaibo, went up by 20% from 10 yen to 12 yen in 2022, it sparked outrage from consumers.[19] Furthermore, there are two kinds of ways Japanese citizens become employed, through regular and non-regular employment. Non-regular employees do not have full-time contracts and are employed on a temporary basis in order to spare company costs when the economic climate weakens. Regular employees are awarded their status on a seniority basis, and their wages across Japan rise every year they continue with the company. Japanese workers also have strong loyalty to their companies and do not generally move between companies as a means of increasing their income.[20]
One of the most recent, significant steps to address Japan’s cycle of deflationary stagnation came from former Prime Minister Shinzo Abe, who in 2013 introduced his “Abenomics” strategy. Abenomics is defined by three arrows: Firstly, fiscal stimulus packages for economic recovery and large-scale infrastructure projects. Secondly, an unorthodox monetary policy where the flow of money was rapidly increased by the BOJ through quantitative easing. It achieved this by increasing liquidity through a large-scale asset purchasing drive and lowering interest rates into the negative zone. There was a significant injection of cash into the economy, but this drove government expenditure even further into a deficit. Thirdly, the Abe government made structural reforms to even further liberalise the business sector in Japan. These included decreased business regulation, the relaxing of labour regulations and cutting corporate taxes. Abenomics was a major experiment in macroeconomic practice and is considered a key case study for economics students.
The BOJ, through its asset purchasing spree, ended up being valued over 70% of GDP, far beyond Western norms. More significantly, it did not achieve its goals; economic growth hovered at 0.5%, inflation remained elusive and consumer spending even slightly decreased.[21] The end of Abe’s term would mark the start of the BOJ’s gradual rejection of negative interest rates.[22]
The government recently achieved slightly higher levels of inflation (around 3%) for two years in a row.[23] The government seeks to break out of the cycle of low economic growth and acknowledges that Japan is falling behind the rest of the region, with South Korea overtaking Japan in average annual wages.[24] However, it needs to approach inflation carefully, as a rapid fall in the value of the yen could lead to even more economic distress as Japan is a food and oil importer. Additionally, the business sector has been reacting relatively well to the moderate levels of inflation, with the government reporting positive increases in wages and investment. Given this, the BOJ and the Japanese government decided to raise the interest rate from a negative rate to a range of zero to 0.1% in March 2024, the first time in 17 years. From this decision, Japan became the last country in the world to ditch its negative interest rate. As many analysts expected, the interest rate was raised again in July to 0.25%. Experts believe that another interest rate hike is on the cards early next year as Japan seriously needs to address its budget deficit. This comes despite the continual failure to encourage consumer spending.[25]
On the other hand, experts at the World Economic Forum suspect that the interest rate will remain as it is for a considerable time. This is a highly symbolic move by Japan as it feels the heat from a slowdown in Chinese growth and an ageing population. Additionally, the benefits of inflation have only really translated to improved wages, which is why the BOJ is continuing with quantitative easing as a means of creating ‘accommodative financial conditions.’ This means that investments from the BOJ are still dearly needed to stimulate the economy. As such, global market environments could easily reverse the government’s new policy.[26] Others argue that Japan needs to look beyond fiscal and monetary policies to achieve its goals, especially a consideration of loosened immigration policies or a means of increasing fertility in order to offset the risks of its ageing population.[27] Nevertheless, the recent increase in wages is a positive first step for the Japanese economy to return to a more conventional form of economic practice. Time will tell whether the BOJ can finally lead Japan to a condition of inflation-led economic expansion, with the potential of a new third phase in Japan’s postwar economic experience.
As a last mention, the Nikkei Stock Average saw its greatest single-session decline since 1987’s Black Monday on August 5, 2024, after only recently recovering from the pre-1990s asset bubble high. On August 6, it made its biggest single-session gain since 2008. What exactly happened? As the yen’s value decreased over the past two years, Japanese companies had recorded record profits through increased exports. The yen’s value decreased as it was being sold off in order to secure higher returns in markets with higher interest rate yields, notably the US. This is also related to the prevalent carry trade, where investors take out low-interest rate loans in Japan and deposit them in markets where the yields are higher, exacerbating the outflow of yen from Japan. As such, when the BOJ raised interest rates to 0.25% in July, the US did the inverse, slashing their rates. The yen jumped from 161/US$ to 150/US$ in a week’s time, sparking an unprecedented sell-off as investors feared that Japanese companies would report lower returns. However, both the Topix and Nikkei indexes recovered to the early 2024 levels, a level which some suspect to be the settling point for the stronger yen.[28]
[1] Taylor, A.M. (2014). The Argentina Puzzle: Microexplanations and Macropuzzles. Cambridge: National Bureau of Economic Research, p.1. Working Paper 19924.
[2] da Silva, J. (2024). The Bank of Japan raises interest rates for second time this year. [online] BBC News. Available at: https://www.bbc.com/news/articles/cw4yz4emgwko [Accessed 14 Aug. 2024].
[3] Kihara, L. (2012). Japan eyes end to decades long deflation. [online] Reuters. Available at: https://www.reuters.com/article/japan-economy-estimate-idUSL4E8JH1TC20120817/ [Accessed 14 Aug. 2024].
[4] Orr, R.C. (2004). Winning the peace : an American strategy for post-conflict reconstruction. Washington, D.C.: CSIS Press, p.183.
[5]The World Bank. (2024). World Development Indicators dataset, “GDP growth (annual %).” Accessed: March 24, 2024. https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
[6] Beckley, M., Horiuchi, Y. and Miller, J.M. (2018). America’s Role in the Making of Japan’s Economic Miracle. Journal of East Asian Studies, 18(1), pp.14–21.
[7] The World Bank. (2024). World Development Indicators dataset, “GDP growth (annual %).” Accessed: March 24, 2024. https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
[8] Kikakucho, K. (1993). White paper on Japanese economy (1973-1979). Tokyo: Business Intercommunications Inc.
[9] Frankel, J. (2015). The Plaza Accord, 30 years later. Massachusetts : National Bureau of Economic Research, pp.8–12. Working Paper 21813.
[10] Quinn, W. and Turner, J.D. (2020). Boom and bust a global history of financial bubbles. Cambridge: Cambridge University Press, p.134.
[11] Asahi Shimbun (2024). Japan’s crazy 1980s bubble a dim memory as Nikkei hits record high | The Asahi Shimbun: Breaking News, Japan News and Analysis. [online] Available at: https://www.asahi.com/ajw/articles/15176172#:~:text=The%203.4%20square%20kilometers%20(1.31 [Accessed 24 Aug. 2024].
[12] Kunio Okina, Shirakawa, M. and Shigenori Shiratsuka (2000). The Asset Price Bubble And Monetary Policy: Japan’s Experience In The Late 1980S And The Lessons. Tokyo: Bank Of Japan, p. 44.
[13] Ibid.
[14] Feingold, S. (2024). Japan Ends Era of Negative Interest rates. Here’s Why. [online] World Economic Forum. Available at: https://www.weforum.org/agenda/2024/03/japan-ends-negative-interest-rates-economy-monetary-policy/ [Accessed 25 Aug. 2024].
[15] International Monetary Fund (2024). Global map of countries’ debt to GDP levels. [online] www.imf.org. Available at: https://www.imf.org/external/datamapper/d@FPP/USA/FRA/JPN/GBR/SWE/ESP/ITA/ZAF/IND [Accessed 25 Aug. 2024].
[16]The World Bank. (2024). World Development Indicators dataset, “GDP growth (annual %).” Accessed: March 24, 2024. https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
[17] The Economist (2013). Waging a new war. [online] Available at: https://www.economist.com/finance-and-economics/2013/03/09/waging-a-new-war [Accessed 26 Aug. 2024].
[18] Nippon (2023). Average Monthly Wage in Japan Reaches New High of ¥310,000. [online] 3 Apr. Available at: https://www.nippon.com/en/japan-data/h01631/ [Accessed 26 Aug. 2024].
[19] Oi, M. (2022). Cost of living: The shock of rising prices in Japan. BBC News. [online] 8 Jun. Available at: https://www.bbc.com/news/business-61718906 [Accessed 26 Aug. 2024].
[20] Nippon (2023). Average Monthly Wage in Japan Reaches New High of ¥310,000. [online] 3 Apr. Available at: https://www.nippon.com/en/japan-data/h01631/ [Accessed 26 Aug. 2024].
[21] McBride, J. and Xu, B. (2018). Abenomics and the Japanese Economy. [online] Council on Foreign Relations. Available at: https://www.cfr.org/backgrounder/abenomics-and-japanese-economy [Accessed 27 Aug. 2024].
[22] Also see De Vos (2023). ‘Introducing Ueda: A new era for the Bank of Japan or same old, same old?’, Introducing Ueda: A New Era for the Bank of Japan or Same Old, Same Old? – Stellenbosch University Japan Centre (sun.ac.za)
[23] Trading Economics (2024). Japan Inflation Rate. [online] Tradingeconomics.com. Available at: https://tradingeconomics.com/japan/inflation-cpi [Accessed 26 Aug. 2024].
[24] Reuters (2024). Japan government considers calling end to deflation, Kyodo reports. [online] Available at: https://www.reuters.com/markets/asia/japan-government-considers-declaring-end-deflation-kyodo-2024-03-04/ [Accessed 26 Aug. 2024].
[25] da Silva, J. (2024). The Bank of Japan raises interest rates for second time this year. [online] BBC News. Available at: https://www.bbc.com/news/articles/cw4yz4emgwko [Accessed 14 Aug. 2024].
[26] Feingold, S. (2024). Japan Ends Era of Negative Interest rates. Here’s Why. [online] World Economic Forum. Available at: https://www.weforum.org/agenda/2024/03/japan-ends-negative-interest-rates-economy-monetary-policy/ [Accessed 25 Aug. 2024].
[27] Menju, T. (2022). Japan is finally facing up to its economic need for immigrants. [online] Nikkei Asia. Available at: https://asia.nikkei.com/Opinion/Japan-is-finally-facing-up-to-its-economic-need-for-immigrants [Accessed 27 Aug. 2024].
[28] Davis, R.A. (2024). Three Days That Rocked Japan’s Markets. The New York Times. [online] 7 Aug. Available at: https://www.nytimes.com/2024/08/07/business/japan-yen-nikkei-stocks.html [Accessed 27 Aug. 2024].