Deflation

In this article I found an interesting solution to Japan’s deflation problems – negative interest rates at the BOJ. I think I had heard of this option before but only in a flippant way and never took it seriously. The author here seems to be very serious about the proposal.

And indeed in the short term such strategies will need to be considered. One of PM Kan’s deflation-fighting measures is the increase in the consumption tax. The idea here is that by improving the government’s fiscal situation, and not worsening government debt any further before the government has to start borrowing from overseas lenders, we can first of all be more sure there will be a sovereign independent country called “Japan” in the future in which to live out your life peacefully, and more so the government will be able to support and sustain the same level of social security spending that will enable you to do this. Thus, people will spend their money now, and not hoard it so they can retire in Hawaii, Bali, or perhaps might I suggest, New Zealand.

Now assuming that this has the desired effect, it is only ever going to be a long-term one as people start to recalibrate their sense of their lifetime earnings (which they will want to do only when the economy recovers….). In the short-term it certainly is not going to help battle deflation, and may well make it worse.

A negative inflation rate could be just the ticket. It is kinda weird and would certainly raise eyebrows of overseas investors….but said eyebrows may already be approaching their owners’ receding hairline. Essentially banks would have to pay the BOJ for the BOJ to keep their money. And since banks are required by law to keep a certain amount of their liquid monetary assets with the BOJ, then it really is in your interests to get the money out the door. Brilliantly tautological.

Of course, a sensible person would immediately ask: “Is a negative nominal interest rate even possible??”.

Apparently, yes, and thanks to Sweden, has been done already.

In economics it is often difficult to separate out the short-term and the long-term and this is no exception. The long-term strategy for fighting government debt and deflation will only work if deflation is not worsened in the meantime (and thus hardening the cultural tendency to save money – deflationary pressures essentially create a negative savings scheme where a constant amount of money appreciates in value) and if the economy is improved (while at the same time increasing the tax base, and not worsening the fiscal situation)- the two things going together. If short-term measures are not taken into consideration, it may well all be for naught.

I think it bears thinking about at the very least.

7 thoughts on “Deflation

  1. I think Will above has it right; there is little point in pushing out more money to the banks if they can’t lend the funds they already have. Lack of capital to lend is not the choke point. To be sure, there are businesses (domestic small operations especially) that have a hard time finding loans, but they are finding it hard because lenders don’t believe they’ll ever get the money back, an echo of the zombie company legacy of the real estate bubble.

    The deflationary problem rather lies on the consumer side – on us. As you say, in aggregate we spend too little and save too much. You would need a negative interest rate on consumers, not banks. The problem is of course that any effective negative rate on consumer lending will be negated by consumers switching to the mattress instead – a form of savings that is pretty much impervious to manipulation of the headline rate. So the negative rate would have to be on consumer borrowing instead – borrow 1000 now, pay back 900 next year. The more you borrow the more you earn! Terms that no lender would accept of course, and the profits would accrue only to those wealthy enough to be able to borrow large sums in the first place.

    But negative borrowing rates really is a money giveaway, so cut out the middlemen, and forget the loan part. Give everyone the money directly. Which, if you remember, is pretty much what the Aso administration tried last year. And it isn’t a completely daft idea. The problem is, it’s in cash so many people would save instead of use it; and the people most likely to spend it – the very poorest – were also the most likely to miss out, because they wouldn’t have a fixed address, problems with the application and so on.

    And seen in that light, improving some forms of social services such as a child benefit, free high schools and tuition credit and so on really functions as a money giveaway, but preferentially going to those most likely to spend the saved money rather than squirrel it away. And that’s without considering the direct benefit of having better services of course. You could argue the same about the dropped highway tolls, but it’s unlikely to be as effective and it has some undesirable side effects.

    • Janne – some very good points there also- glad to have raised the issue. I personally favour interventions such as the child allowance which in general give money to those most likely to consume as well as have beneficial effects over and above their short-term stimulatory effects. I think when I discussed this on the blog last year I suggested I was less convinced that giving money to public organisations rather than citizens – I know first hand that such organisations have ways of making things “cost” more than they do – especially in Japan. But that seems to be the way things are going, and it could be worse.

      I agree about Aso’s stimulus plan being underwhelming – in terms of both scale and intent – but I thought a really good aspect of it was the Eco-points stimulus plan – I think that it ticks all of the right boxes in terms of incentivising good behaviours of various kinds. I don’t see why they could not apply variations of the idea to other industries, “ecological” or otherwise. But of course, that would require that the government has a long-term plan about which industries it will strategically focus on and thus be able to put the money to maximum effect. The DPJ to be fair seems to moving towards that direction, oh so slowly.

  2. I don’t think this quite works for deposits as a long-term policy (fine in the short term as in Sweden’s case).

    If you have a negative interest rate on the deposits with a central bank, of course banks will reduce their deposits with the central bank to the minimum legally required of them. They can’t then reduce deposits any further except by minimizing their own customers’ deposits with them, which as it is now effectively an expense they will be incentivised to do.

    Now if they make sufficient money on the fraction of the customers’ monies that they do not have deposited at the central bank, then no problem. But in fact, the rates of return on investment here in Japan are sufficiently low that this is not necessarily the case – correct me if I’m wrong. Bear in mind as you consider this that in most countries banks are not allowed to invest the funds in ordinary current and savings accounts in any high risk investments (at least that are not themselves backed by sufficient guarantees), so we can exclude the highest-returning investments from our determination of the likely return on the funds in customers’ ordinary accounts.

    So in this admittedly extreme scenario suddenly banks will be encouraged to set up accounts that actually discourage their customers from saving with them (ie. hold only what you need for transactional allowances), and this would mean customers would be incentivised to keep their money under the mattress.

    I know it’s a fairly bizarre situation, but it’s not impossible if you combine negative interest rates with required deposits and low rates of return, and I think Japan could provide this. I just don’t think the idea would actually work.

    On the other hand, for negative interest rate scenarios discussing the rate at which banks borrow from the central bank, I would argue that’s a completely different situation. It’s also worth noting that even that would have no stimulatory effect on the economy if the economy is not currently held up by lack of available capital – and the low rates of return on investment here suggest that this is not the case, rather it is the lack of opportunities worth pursuing in the face of the current population statistics etc. Furthermore this is not the case in say America or even a lot of Europe, so a negative lending rate would just mean banks investing in everyone else’s economies.

    • Hey Will thanks for taking the time to respond. While I digest the rest I will clarify a couple of points.

      First I certainly don’t think this would be a sensible policy for more than a couple of years – just long enough for government to at least look like they are getting their act together on demographic and fiscal issues without compounding the problems.

      As for levels of capital available – it is generally assumed that in Japan of the last couple of years, like the early 90s Japan that low availability is ruling the roost – my understanding of this comes from Richard Koo’s idea of a balance sheet recession, but certainly social dynamism and demographic issues play their part. I wonder if this is one of a suite of potential tools that will need to be used to get Japan on the a sustainable trajectory again rather than rely on some magic bullet. Corporate tax cuts are being considered also as they are very high which of course has a number of effects.

    • Oh, and to add Will – to be sure the mattress problem has a very long tradition in Japan already so you may well be right in that it may not work, especially on its own as policy – there is no reason to believe that people will spend the money that they are incentivised to not keep in banks. My understanding is that such a policy would help push banks to lend out more of their money to businesses which is what they are said to not be doing now. Whether that is the behavioural outcome nobody really knows.

  3. Perhaps I’m not right person to comment here. But as a poor japanese I am pleased with the deflation. Even now the prices in Japan are still higher than other contries, I guess.

    • Hi Masa – sure from time to time a bit of deflation is not in itself a significant issue – but there is “deflation” on for example retail and utilities items due to competition and more choice in certain industries, – and then there is “economy-wide” deflation – which usually means, if occurring over a long period of time, people and businesses change their behaviour, spend less, but also pay less wages and create less, or even reduce, employment. Japan has certainly had some of the first kind, but unfortunately a lot of the second kind also.

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