Political Pulse

Price stability a long-unsolved conundrum for Japan

The Yomiuri Shimbun
Bank of Japan Gov. Haruhiko Kuroda speaks in Chuo Ward, Tokyo, on June 17.

By Akihiro Okada / Editorial writer for The Yomiuri Shimbun

8:00 JST, July 2, 2022

“Irrational exuberance” is a phrase widely used to warn about the risks of a bubble-like stock market.

Former U.S. Federal Reserve Chairman Alan Greenspan first used the term at a dinner and lecture in Washington on Dec. 5, 1996. He wanted to sound the alarm over an overheated stock market that could undermine financial markets and economic stability.

However, it was something of a taboo for the Fed chairman to mention a reasonable stock price level. If the Fed chairman, who has tremendous influence over the economy, were to say that the economy was “in a bubble,” he would be perceived as making a definitive judgment, which would roil the market.

Therefore, he cautiously embedded the coined term “irrational exuberance” late in the drafting of his speech. It was inserted so discreetly that when Greenspan returned to the table after his speech and asked those around him what part of the speech they thought would be newsworthy, no one could answer. But the media noticed and reported the implications of these words, and a stock market adjustment followed. Later it became a standard warning phrase.

That’s how Greenspan recalled it in his memoir, “The Age of Turbulence.”

He is praised as a great central banker and a “maestro” for the long-term prosperity of the U.S. economy, although Greenspan’s reputation was somewhat tarnished by the 2008 financial crisis, for which critics have held him partly responsible. He was also a master communicator with the markets. As a central banker, he was always required to choose his words carefully. Greenspan did just that and did it very well.

In comparison, a recent comment by Bank of Japan Gov. Haruhiko Kuroda was less cautious.

In a June 6 speech in Tokyo, Kuroda said, “Japanese households are becoming more tolerant of price hikes, which can be viewed as an important change from the perspective of achieving sustainable price increases.” Kuroda’s remarks provoked a strong backlash. Households are not taking price hikes in stride, and many have complained that they have no choice but to accept higher costs for products essential to their daily lives. Later, Kuroda retracted his controversial statement in the face of criticism from lawmakers and consumers.

Kuroda’s statement was not just a gaffe. This is because the drafts of the governor’s speeches are carefully checked by the secretariat in advance, aiming to always make sure that there are no problems.

Why did he make such a statement? Let’s take a look back at the history of the BOJ’s monetary policy.

In the spring of 2013, immediately after he took office, Kuroda deployed a “bazooka” asset-buying program to shock the public out of a deflationary mindset. However, nine years have passed since then, and the 2% inflation target — seen as a desired virtuous economic cycle that also includes continued favorable wage growth — has not been achieved.

In Japan, where deflation has persisted for a long time, expectations of zero inflation are deeply rooted, and both firms and households operate on this basis. This has created a strong “norm” that continues to plague the BOJ.

The desirable mechanism for price increases is as follows: Higher wages lead to increased consumption, which leads to firms being able to raise prices, which leads to increased profits, which leads to firms being able to raise wages again.

The question is where the starting point for this virtuous cycle should be. It seems natural that the starting point should be a wage increase. However, because of the low mobility in the Japanese labor market and the emphasis on long-term stable employment, workers do not necessarily have strong bargaining power to raise wages.

Therefore, the BOJ was watching carefully to see if the cost-push inflation that occurred this time would be the starting point for a breakdown of the strong norm. Once the norm was broken, there was a possibility that the virtuous cycle mechanism would begin to turn. It may have seemed like a ray of sunshine. The BOJ was too focused on this mechanism while lacking awareness of the public’s sensitivity to prices, and thus overlooked the troubling statement.

The growing criticism of Kuroda’s statement reminds us of another matter. That is, whether the public perceives a 2% inflation rate as price stability.

The BOJ has a legal mandate to achieve price stability. When the BOJ ended its quantitative easing policy in March 2006, it announced its view that a 0% to 2% year-on-year change in the consumer price index was its understanding of price stability, with most board members’ median figures falling on either side of 1%. In February 2012 it clarified its outlook, setting its inflation goal at 1%.

However, this monetary policy was criticized for causing the yen to appreciate and for being the reason why deflation could not be completely overcome. Therefore, Kuroda was appointed and introduced new monetary policy with a 2% inflation target.

Even though the consumer price index in Japan is rising now, it has only reached a growth rate of about 2%. This represents a huge gap with the West, where inflation is over 8%. Nevertheless, as in Europe and the United States, complaints about high prices have erupted in Japan, highlighting the Japanese people’s strong wariness toward inflation. In particular, the rising prices of food and energy, partly caused by the weaker yen, have put the country in a difficult situation.

That said, I think it would be difficult to change the 2% inflation target. If the inflation target is changed to 1%, the risk of a reversal to a stronger yen and weaker dollar would increase, and the risk of deflation could also increase again.

This price controversy provides a new opportunity to consider how to achieve price stability and economic growth in a way acceptable to the public. It is important to have a concrete image of how the 2% inflation target will be achieved, what form of price hikes would be acceptable to consumers, and what path will be taken to achieve this goal. I would like to emphasize again the importance of delving into the Japanese people’s view of price stability.

Before the COVID-19 pandemic, the term “Japanification” was often heard among policymakers in advanced Western countries, who used it as shorthand for the economic problems that undermined Japan.

This was based on the fear that the United States and European countries could also be heading into a state of Japanification where they cannot escape a period of stagnation, defined by weak growth, ultra-loose monetary policy, and deflationary pressures, which had been thought to be unique to Japan. However, with the supply shock from the COVID-19 pandemic, the policy theme in Western countries returned from fear of Japanification to fear of traditional inflation.

Meanwhile, in Japan, prices are high, but the CPI increase has been limited to about 2%, much lower than in the West. For this reason, while Western central banks are moving to tighten monetary policy, the BOJ has been left behind and continues its ultra-loose monetary policy. Once again, the uniqueness of the Japanese economy stands out.

In fact, Greenspan’s exhortation against irrational exuberance, mentioned at the beginning of this column, actually invoked Japan: “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

Greenspan was trying to draw lessons from the mysteries of the Japanese bubble economy. A quarter of a century later, the challenge of Japan’s secular stagnation remains unsolved. From the perspective of other countries, it will continue to be a conundrum. Japan was, and still is, a unique country.

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