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Home Publications Blogs Beat the Press Japan's New Economic Program Faces Risk of Runaway Inflation and Attacks from Martians

Japan's New Economic Program Faces Risk of Runaway Inflation and Attacks from Martians

Friday, 05 April 2013 04:42

In a piece on the new initiative by Japan's central bank to raise its inflation rate to 2.0 percent, the Washington Post told readers:

"The risks are known but impossible to quantify: of inflation remaining tame until it roars out of control, or of asset bubbles creeping into unexpected parts of the economy as investors take advantage of cheap money worldwide to make ever-riskier bets."

While central banks, like the bank of Japan and the Fed, have displayed an enormous lack of competence in recognizing and countering asset bubbles, there are no known instances of inflation remaining tame until it "roars out control," apart from countries victimized by war or natural disaster. This horror story seems to be entirely an invention of the Post (or its unnamed sources).

In all the standard models inflation is a process that builds up gradually over time once an economy is hitting capacity constraints. Economies do not just jump from being severely depressed to having soaring inflation. For this reason, serious people would view this prospect with roughly the same concern as an attack from outer space.

It is also worth noting that this piece places an excessive emphasis on deflation. Japan has occasionally seen modest deflation (a drop in annual prices of less than 1.0 percent annually) over the last two decades. There is no particular importance to having deflation as compared to an inflation rate that is too low.

The issue here is that it would be desirable to have a lower real interest rate given the weakness of Japan's economy. (The real interest rate is the nominal interest rate minus the inflation rate.) Since the nominal interest rate can never go below zero, the only way to lower the real interest rate is to push inflation higher.

For this reason, deflation is harmful, but only in the same sense that a lower inflation rate is harmful. A decline in the rate of inflation from 0.5 percent to -0.5 percent is no worse than a drop in the inflation rate from 1.5 percent to 0.5 percent. There is no magic about crossing the zero line. It is unfortunate that the Post and other news outlets have fostered so much confusion on this issue.

Comments (6)Add Comment
written by foosion, April 05, 2013 6:25
The real interest rate is the nominal interest rate minus the inflation rate

That should be the real interest rate is the nominal interest rate minus the expected inflation rate
written by Union Member, April 05, 2013 6:38
"The risks are known but impossible to quantify

Godzilla is slouching toward Tokyo.
Japan: The Widowmaker of Hotshot Traders
written by Chris Engel, April 05, 2013 8:32
Japan is the widow-maker of hedge-fundies and wanna-be economists who are just compulsive gamblers, err I mean respected market traders.

Economists understand the mechanics driving Japan.

But traders see a debt/gdp ratio and try to short the bonds and kill the Yen, and fail time after time after time...no comprehensive analysis from them at all.

You'd think after they have been wrong for over 20 years they would learn their lesson...
Morality in economics reporting is always a clue...
written by Ryan, April 05, 2013 10:12
The tip-off for me were the words "tame" and "roars." What I've never understood is why reporters just wouldn't look for evidence; aren't they in the business of reporting, and not fortune telling. Is it possible to get people who look for evidence to do the reporting?
written by nassim, April 05, 2013 10:37
seems to be entirely an invention of the Post (or its unnamed sources).

I think you meant "or its untamed sources" roaring about untamed inflation.
written by skeptonomist, April 05, 2013 11:46
There have been no cases of inflation suddenly roaring out of control absent wars or commodity shocks or certain other conditions, but there have been no cases (that I am aware of) of a central bank building up huge excess reserves as the Fed has done and as Japan is apparently planning to do. The BoJ says it will double the monetary base if necessary. Of course the Fed has more than tripled the US monetary base since 2008 and this has had no detectable effect on inflation, so there is no reason to expect any immediate effect in Japan either. But what will happen if either economy starts booming? Dean makes the reasonable assumption that central banks will increase reserve requirements, but central bankers don't always do the reasonable or wise thing. Counting on central banks to control things in the future is not a good idea, since there is no evidence that they have controlled them in the past.

According to Krugman's speculative idea of "monetary credibility", central banks promise that they will not act to control inflation in the future, at least until some high level is reached; and this promise itself leads to inflation, which is presumably desirable up to that arbitrary level. So is the BoJ action going to cause inflation or not? And if and when inflation does get started why would anyone assume that a central bank can control it at some stated level? Did the Fed or any other central bank control inflation at 2% - or any level - during the the 70's and 80's (or at any other time when there were actual inflationary pressures)? A large number of economists' predictions and even factual claims about the powers and effects of monetary policy have been falsified, whether they realize it or not. There is not much credibility or science to the claims of any of the factions on these monetary issues.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.