The ending of Japan’s zero interest rates marks the end of an extraordinary policy prompted by a situation not seen in any other major economy in post-war times — deflation.
Before the “bubble economy” excesses of the 1980s came to an abrupt end, inflation had been the biggest fear on economists’ minds, with monetary policy aimed at keeping prices in check to ensure steady growth.
Then, in the late 1990s, came a different spectre in Japan, one of deflation where consumers, seeing prices fall, decide to wait before making any purchases in the hope of getting their goods even cheaper still.
The upshot is a descending spiral of falling prices and ever weaker demand, which feed off each other and undercut growth and employment in turn.
The Bank of Japan’s answer was to set interest rates to zero in the hope of stopping the rot and generating some sort of demand expansion.
“Japan is the only major economy to have experienced a sustained, debilitating bout of bad deflation in the post-war period,” notes Glenn Maguire, chief Asia economist at Societe Generale in Hong Kong.
Japan entered its deflationary spiral in the wake of the bursting of the asset bubble in the early 1990s. Soon Japanese were shunning sushi restaurants for 65-yen ($0,55) hamburgers or cheap noodle bars.
In a country famous for its sky-high prices, it was obvious something strange was happening to the world’s second-largest economy when “100-yen” shops started opening up across Japan. The equivalent of the United States’s “dollar stores”, they quickly filled the space vacated by failed businesses.
Falling prices may sound like good news for consumers, but with the value of their homes and other assets falling and little prospect of a pay rise, few were rushing out to splurge their precious cash on luxuries.
Company profits slumped. Unemployment doubled. Before long the parks were dotted with the blue tarpaulins of the growing number of homeless. Government debt soared and soon Japan had a credit rating lower than that of Botswana.
From 1997 to 2005, consumer prices in Japan fell by a total of 2,6%, excluding perishable goods, returning to the levels of the early 1990s.
Bank lending started to shrink and companies stopped borrowing. The banking industry was crippled by a mountain of bad debts and is only just emerging from its long crisis after a series of government bailouts and industry mergers.
In 1999, with the aim of ending the deflationary spiral, the Bank of Japan adopted the policy of zero interest rates.
When this failed to solve the problem, it began flooding the banking system with virtually free cash in 2001, an unprecedented measure called “quantitative easing” aimed at encouraging borrowing and stimulating growth.
“The key feature of deflation is that policy loses traction. As the nominal interest rate hits zero, conventional monetary policy becomes impotent,” said Maguire at Societe Generale.
Now, however, deflation finally appears to be all but history with core consumer prices up for a seventh straight month in May, allowing the central bank to raise interest rates for the first time for almost six years on Friday. — AFP