Last week I mentioned Japan in an article about France. Quoting an article from Forbes Magazine I made the point that Japan has been stuck in the liquidity trap for a very long time, and that the inflation the country is now experiencing is of the dangerous, monetary kind. The Japanese story illustrates why it is so dangerous for Europe to try to get out from underneath a perennial recession by aggressively expanding money supply.
The lesson for Europe stands firm: printing money when there is no demand for that money is a thoroughly bad idea, and Japan is a good example of why. From the time the Japanese deflation era started, in the late ’90s, the growth rate in the money supply accelerated. This went on for most of the next decade and a half; coincidentally, starting in the late ’90s Japan experienced almost 15 years of deflation.
It is, in other words, safe to warn the Europeans that massive expansion of the money supply will not break deflation. But it is also important to acknowledge that Japan is now showing signs of leaving deflation behind, just as the Forbes article suggested.
The problem is that the new Japanese inflation is not of the kind that Forbes suggested. I quoted the article and took its point as given – it referred to a side point in my article and therefore I accepted the conclusion of what looked like a credible source. But I also had an unrelenting feeling that I needed to look into the veracity of the point from the Forbes story. After all, if Japan had suddenly gone from deflation to inflation without an underlying upturn in real-sector activity, there would be a big case for studying the transmission mechanisms that channeled all that extra liquidity into prices.
In other words, it would have been a historic opportunity for monetarists to prove that their theory of inflation is actually true. It would be “true in the long run”, a 15-year long run, but it would nevertheless be true.
As I started digging through national accounts data it turned out that Japan is not at all entering an era of monetary inflation. The push upward on prices originates in the real sector: production, consumption and gross fixed capital formation (business investment).
Figure 1 reports inflation-adjusted growth in GDP (all data reported below is from Eurostat):
Japanese GDP growth exhibits some volatility, but since 2011 the trend is closer to the American economy than the euro zone.
Figure 2 reports private consumption growth:
Here the trend is actually fairly good for an economy that has been stagnant for almost two decades. It is still nothing to cheer about – Japan, like the United States, cannot break the Industrial Poverty line of two percent. But at least Japanese consumers are out there spending money, which is far more than you can say about their peers in the depressed euro zone.
Figure 3, finally, tells the story of business investments:
This is perhaps the most compelling piece of evidence that the Japanese economy is in recovery mode after 15 years in the economic wasteland. Growth rates in corporate investments are not ecstatically high, but they are the best since the mid-’90s. Again, activity in the Japanese economy is showing the same modest but real recovery tendency as the American economy.
Normally, growth rates around two percent should not even come close to driving inflation. However, with 15 years of stagnant business investments there is very little excess capacity in the economy. Add to that a shrinking work force and the capacity ceiling is lower in Japan than in many other economies.
So there you have it. Japan is leaving the shadow realm of stagnation and deflation. The real sector is recovering, and with production capacity adjusted to stagnation, not growth, excess-demand inflation sets in earlier than in, e.g., the United States. Not to mention Europe.
The Japanese deserve kudos for their apparent return to growth. Let us hope they keep it up.