Japan Is Back. Is The Defeat of Deflation the Reason?

livemint.com:

The Nikkei stock index recorded last week its first new high in 34 years, a fitting tribute to Japan’s re-emergence as a genuinely exciting economy. It also comes amid mounting evidence that Japan has finally broken the hold of deflation. Inflation in January was 2.2%, the 22nd month above 2%.

Wage growth has picked up too. This appears to vindicate the economic consensus that deflation was a primary driver of Japan’s decades long malaise. But that conclusion might be premature.

Proof of deflation’s harm has been elusive, and the benefits of low, positive inflation might be similarly subtle. Consumers are often surprised to hear that deflation is supposed to be bad. In the U.S., where prices have risen steeply since 2021, normal people, and even economists, wouldn’t object if they fell a bit.

The trouble arises when prices fall persistently, year in and year out, because wages, incomes and the prices of assets such as property tend to follow. Debtors struggle to repay loans and might slash spending or default, endangering the financial system. That is what happened in the U.S.

when prices fell 27% from 1929 to 1933. Even mild deflation can, in theory, inhibit growth. Central banks stimulate spending by lowering nominal interest rates below inflation to make the real—i.e., inflation-adjusted—cost of borrowing negative.

That is almost impossible when inflation is itself negative. Japan’s deflation began after its property and stock-market bubbles burst in the early 1990s. Ensuing losses at banks eroded their ability to lend.

Inflation turned negative in 1999. Western economists such as future Federal Reserve Chair Ben Bernanke argued that curing deflation was essential to restoring Japan’s economic health. The Bank of