Why Japan Hasn't Declared Deflation Over, Even as Prices Rise

The government’s considering four data points in its decision
Haruhiko Kuroda, governor of the Bank of Japan (BOJ), poses for a photograph before delivering a speech at the University of Zurich in Zurich, Switzerland, on Monday, Nov. 13, 2017. Kuroda said the central bank can help avoid negative price shocks and achieve its 2 percent inflation target by working on inflation expectations through forward guidance. Photographer: Stefan Wermuth/Bloomberg

While Japan’s consumer price index has been inching higher for almost a year, the government still hasn’t declared the nation to be officially free of deflation.

The question of how you can have rising prices but not be out of deflation might seem like a point for bureaucrats and academics to debate, but it has real-world implications for Japan. The government will likely need to pass this milestone before it can go ahead with a planned increase to the sales tax and the central bank may find it difficult to do anything more than stealth tapering of its monetary stimulus unless the deflation demon is pronounced dead.

The time could be ripe for a decision around the end of 2018 as economic conditions fall into place, according to Masamichi Adachi, a former central bank official and now senior economist at JPMorgan Securities Japan. Bloomberg Economics’ Yuki Masujima notes that adjustments in the Bank of Japan’s yield-curve program could follow an eventual announcement on exiting deflation.

These are four key measures the government is watching to help guide its decision:

The core consumer price index

CPI has increased steadily over the past year, but maintaining that momentum means that inflation expectations need to become firmer, according to Adachi. "People and corporates both need to have confidence that prices will continue to rise," he said.

The output gap

The output gap serves as a gauge of demand in the economy, with a positive reading indicating more demand. Further increases into positive territory should boost prices more.

The gross domestic product deflator

The GDP deflator is an important measure of inflation that uses output data, rather than a basket of goods and services like CPI. The deflator rose 0.1 percent in the third quarter from a year earlier, pointing to weak price increases.

Unit labor costs 


This measure in part reflects changes in compensation to workers. It provides a marker by which policy makers can assess wage inflation, another crucial element that’s required to truly exit deflation. It rose 0.4 percent from a year earlier in the third quarter, according to Bloomberg calculations.

Adachi cautions that these guideposts alone won’t determine when a pronouncement is made. A subjective sense of whether Japan has left behind economic stagnation and downturn, also considered part of "deflation" in Japan, will also come into play, he said.

That means economists will be watching closely for any shift in comments from policy makers like Finance Minister Taro Aso, who’s repeatedly spoken of the difficulty of beating, once and for all, the "deflationary malaise."

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