How the Japanese learned to live with deflation, and enjoy it
In June 2011, then-BOJ governor Masaaki Shirakawa faced extreme pressure to double the monetary base, a step Kuroda took just days after replacing him in March. When Shirakawa, a University of Chicago-trained economist, was asked why he'd refused to budge, he offered a surprising excuse: Japan's ageing population, whose fixed incomes would be eaten away by rising prices. Politicians thought the rationale was a cop-out. Shinzo Abe's first act as prime minister was to dump Shirakawa.
Turns out, Shirakawa was on to something. In a new paper, Shock from Graying: Is the Demographic Shift Weakening Monetary Policy Effectiveness?, International Monetary Fund researcher Patrick Imam offers convincing evidence that ageing societies in Japan, Germany and, to some extent, the US can no longer be manipulated so easily by central bank policies.
Why? Changes in official interest rates are about influencing long-term expectations and short-term behaviour. Cutting rates is meant to make buying a new house, opening a business or betting on stocks more attractive today than next year. But such activity is disproportionately conducted by the young. That's Japan's problem. Today, one in four Japanese is older than 65; by 2060, that group will swell to more than 40 per cent of the population.
Even that isn't the whole story. Along with ugly demographics, Kuroda faces a Japanese public that has learned not only to live with deflation but also to enjoy it.
By 1990, asset prices weren't the only things that had veered into bubble territory in Japan. Arguably, the entire economy had. As the 1970s gave way to the heady 1980s, costs rose throughout the economy: food, transportation, service fees, power, telecoms, education, entertainment, apparel, you name it.
The story of Japan these past 20 years, from the government to banks to companies, has involved keeping consumer prices steady. Deflation has acted like a stealth tax cut for households and restored some sobriety to costs.
When economist Kosuke Motani made this argument in his 2010 book, The Real Face of Deflation, it fell with a thud in Nagatacho, Tokyo's Parliament precinct. Motani thinks Japan is experiencing "non-monetary deflation" on account of a national cost structure that overshot to the upside decades ago, a greying population that favours falling prices over rising ones, and a political system that doesn't understand deflation is a symptom of Japan's malaise, not the cause.
The theory among neoclassical economists that quantitative easing can overcome deflation, Motani argues, is "just like a religion". (He could as easily have said "cult".) As odd as it sounds, Japan's deflation has been as much a choice as a punishment. In order to avoid big, destabilising reforms, the government has amassed mountains of debt. Deflation, which lowers nominal bond yields, makes that burden easier to service.
This is the paradox facing Abe and Kuroda. Until now, the focus has been on how bond traders will react as a nation whose debt is approaching 250 per cent of GDP, and which enjoys sub-1 per cent 10-year bond yields, begins to produce sustained inflation. Equally important is how the nation's 126 million people, many elderly, cope.
"In Japan, all players have adapted to a deflationary environment: Households are used to increasing living standards without expecting higher wages, companies live from cost-cutting without fighting for bigger markets, the government needs low interest rates for most of its finance," says Martin Schulz, a former BoJ researcher and now senior economist at Fujitsu Research Institute. "Turning all this around will not be easy."
Frequently Asked Questions about this Article…
Japan's deflation refers to persistently flat or falling consumer prices over decades. According to the article, it is partly “non-monetary” — a legacy of an oversized national cost structure from the 1980s, a greying population that prefers falling prices, and political choices that avoided big reforms. Deflation has acted like a stealth tax cut for households and helped keep costs down, so many consumers and businesses have adapted and come to accept (and in some ways benefit from) lower prices.
Research cited in the article (IMF researcher Patrick Imam) argues that monetary policy works by changing expectations and short-term behaviour — actions disproportionately taken by younger people (buying houses, starting businesses, investing). With one in four Japanese already over 65 and that share rising, fewer people respond to interest-rate cuts, weakening the transmission of central-bank tools like rate cuts and quantitative easing.
Masaaki Shirakawa argued that raising the monetary base risked hurting Japan’s large elderly population on fixed incomes, whose purchasing power would be eroded by higher prices. Politicians saw that rationale as insufficient and replaced him; his successor, Haruhiko Kuroda, moved quickly to expand the monetary base in an effort to spur inflation.
The article explains that deflation lowers nominal bond yields, which makes servicing large government debt easier. Japan’s high debt load (described in the article as approaching historically large levels) is less burdensome when interest rates and nominal yields stay very low — a key reason deflation has been politically tolerable.
The article highlights a key concern: sustained inflation could change how bond markets view Japan’s large debt and could push up long-term yields from their sub-1% levels. That would affect bond prices and the borrowing costs for the government, and could also challenge households and companies that have adapted to low-price conditions. Investors should watch bond yields and policy signals from the Bank of Japan.
Economist Kosuke Motani uses the term “non-monetary deflation” to describe Japan’s price stagnation driven not primarily by central-bank policy but by structural factors: an overbuilt national cost structure, a greying population that favours falling prices, and political choices that treat deflation as a symptom rather than the cause of economic malaise.
As noted by former BOJ researcher Martin Schulz, households have learned to maintain or improve living standards without expecting higher wages, and companies focus on cost-cutting rather than aggressively seeking bigger markets. This widespread adaptation makes reversing deflation challenging, because many economic actors have adjusted expectations and business models to a low-price environment.
Quantitative easing is a monetary policy tool intended to influence long-term expectations and encourage spending and investment today. The article notes critics’ views — including Motani’s and Imam’s research — that QE relies on behavioural responses more common among younger people. In ageing societies where fewer people are likely to change spending or investment patterns, QE may have limited power to restore sustained inflation.
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