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Monday, Feb. 20, 2012
Lost in inflation: the trap of focusing solely on the consumer price index
Special to The Japan Times
Japan's wholesale price index has consistently been on the rise since December 2009 due chiefly to rising oil and food prices. But the consumer price index has fallen year on year for three years in a row. One reason behind the decline in the CPI is the rising influx of cheaper, high-quality products from overseas. This is reflected by globalized Japan's descent into its first trade deficit since 1980 and by the rivers of red ink flowing from its once mighty electronics makers.
As tax revenue continues to fall and the budget deficit stays big, the government's fiscal policy options are starting to run out. As a result, expectations are mounting for a monetary solution to the ailing economy.
To cope with the persistent decline in consumer prices, the Bank of Japan has basically maintained a so-called zero interest rate policy since February 1999. In addition to various measures to boost market liquidity, the central bank effectively set an inflation target last week, saying it would manage monetary policy toward its goal of achieving a 1 percent annual gain in the consumer price index. However, there are already doubts about whether the step will have any impact. Here are several reasons why.
First of all, it must be noted that the CPI is calculated by combining prices for goods (such as food and clothing) and services (like transportation and medical care) purchased by households, turning them into an index, and gauging how the index fluctuates over time. In other words, it is not an indicator of price levels in itself.
Second, prices in Japan remain very high by international standards. For example, if we were to set the price of a liter of milk and a kilogram of beef in Japan at a level of 100, the corresponding figures would be 45.6 and 68.2, respectively, in Britain, and 46.1 and 45.4 in Washington, according to the Japan Center for International Finance.
This particular disparity does not seem to be widely recognized by the public and the entire nation is convinced we are in deflation.
Why is there so much debate about Japan's participation in the Trans-Pacific Partnership Agreement? Because we impose import tariffs of 778 percent on rice and 250 percent on wheat. In other words, Japanese consumers pay 7.8 times more for rice and 2.5 times more for wheat than their overseas counterparts. This is one factor behind Japan's high prices.
Prices are high not only in the flow economy, but also in the stock economy, which includes assets like land and housing.
An international comparison of condominium prices shows that salaried workers here pay an average of 5.77 times their annual salaries to purchase a condo, compared with 5.14 in Britain and 4.35 in the United States. The gap only expands if differences in unit size are taken into account.
The third factor is the cost of labor. The wages of Japanese workers remain extremely high by international standards, and companies are expanding production abroad in pursuit of cheaper labor. Power shortages and higher electricity rates are likely to accelerate this trend. Wage levels are declining at home, and there is little prospect of winning substantial wage hikes in the upcoming "shunto" spring labor negotiations.
The fact that production costs are still high in Japan proves that the hangover from the bubble economy of the late 1980s and regulatory red tape are still haunting the economy. Meanwhile, falling prices are effectively boost the purchasing power of households that cannot pin their hopes on wage increases.
These observations suggest that the phenomenon called "deflation" in this country is just the process by which market forces are pulling Japan's lofty prices back down to the international average as globalization works to standardize the cost of production elements across national borders.
So rather than deflation, price levels in Japan are actually still in a state of inflation. How then can a zero interest rate policy be counted on to spur the economy?
Monetary authorities shouldn't focus solely on the consumer price index when making decisions. They should step back and take a look at the big picture, including Japan's abnormally high prices, and draft new policies accordingly.
It may even be necessary in fact to create a whole new pricing index that puts Japan's in a proper context for international comparison.
Teruhiko Mano is an international economic analyst.