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Monday, Sept. 8, 2003
Taking the blue pill in a deflationary world
By NORIKO HAMA
"Welcome to the real world," says Morpheus, captain of the hovercraft Nebuchadnezzar. That is how the cult-movie serial "Matrix" first ventured out into its progressively surreal world. Fans avidly await the coming of the third and (supposedly) last installment of the saga later this year.
Meanwhile, the real economy in Japan is beginning to look increasingly more illusory, if not quite totally surreal. "Welcome to the real world" might well have been the sentiment of Mr. Heizo Takenaka, the economics and finance minister, when he commented on Japan's GDP statistics for the April-June quarter released in August. Indeed he actually went so far as to say that the GDP growth figure came out a lot stronger than he had dared hope. A not entirely unjustifiable sentiment, since the figure came in at a rather robust quarter-on-quarter growth of 0.6 percent. In real terms, that is to say.
However, in nominal terms, or before adjustment for price developments, the equivalent quarter-on-quarter growth rate was a mere 0.1 percent. How can that happen? It happens because prices are falling. Welcome to the world of deflation. In a world of falling prices, strong real term growth is nothing to rejoice over. A fat lot of good it would do people if they were selling large amounts of goods but losing money doing so because of falling prices.
Force of inflationary habit induces us to differentiate between the real and the nominal, with the implication being that the latter is an illusion caused by inflation and that the real is a better gauge of the state of economic activity.
True, it would be an illusion to think that just because your wages had doubled overnight you had become that much richer, if in the meantime your cost of living had gone up by the same amount. Back in those times, when this kind of monetary illusion was rampant, policymakers were correct to draw attention to the real economy if it looked as though people were being too carried away by the apparent size of their wage packets.
But now that deflation -- not inflation -- has become the fact of economic life here, it is anachronistic at best, and deceitful at worst, to boast about a better-than-expected real growth figure while the reality of the nominal economy remains one of declining general price levels.
From this perspective, the recent upsurge in long-term interest rates is very worrying. Those rates have no business rising while deflation remains in place. Mr. Toshihiko Fukui, the Bank of Japan governor, therefore had it right when he gave his assurance that he will stick with the current highly accommodative monetary policy as long as price developments remain in negative territory.
That focus on deflation is sound. Whether or not he can do much good is another matter. In fact, it could be argued that the very amount of excess liquidity the BOJ has been pumping into the financial system is actually a part of the problem. That excess liquidity has to have somewhere to go. So it surges between the bond and stock markets at the drop of a hat, causing interest rates and stock prices to go where they ought not to be going. Thus what was supposed to be the solution can all too easily turn into the cause of yet another problem.
Such is life in the topsy-turvy world of deflation. In a world where the real and the nominal have interchangeable meanings, anything can happen, as the Wachowski Brothers, the creators of the world of the "Matrix," would surely delight in telling us.
Noriko Hama is an economist and a professor at Doshisha University School of Management.