International Finance, Japan Economy - Inflation and Aggregate Demand - Consumer Price Index

Inflation and Aggregate Demand

Consumer Price Index

Japan’s consumer prices are falling for the last six months and in August fell to negative 0.5. Japanese government have an inflation target of 2% and it is finding it hard to achieve that targets with the falling prices of the consumer goods and the appreciation of the Yen.

Source:Bloomberg
[pic 1]

Japan had some initial success with Abenomics which helped increase the CPI over its target of 2% at the beginning of 2014. However, due to the increasing budget deficit Japan increased the taxes in 2014 to cover the deficit, which along with the decrease in the oil prices led to an immediate decrease in consumption and prices leading to the decrease in the inflation, which fell below the 2% target by the end of 2014.

Oil Price Impact on CP

In general, for energy importing countries a decrease in energy prices is good for the country’s net exports. As the cost of production decreases, which makes the exports more attractive to foreign buyers, resulting in increased profits. With a high percentage of energy imported, energy prices have a large influence on Japan’s inflation - mineral fuels made up 23% of the country’s imports in 2015 However, the results of decreasing oil prices were not as expected in Japan. Oil turned out to be a mixed blessing for Japan. The lower oil prices resulted in decrease in the consumer goods prices which resulted in decrease in inflation and pushed Japanese economy into deflation. Deflation is dangerous as it discourages the consumers from making purchasing. When economy goes into deflation, consumers can go into a phase where they infinitely delay their purchases expecting the prices to fall because of deflation and thus happening any economic activity in the country. Abenomics did not anticipate the impact of decrease in oil prices and it became very difficult for Japanese government to get out of deflation.

Moreover, increased corporate profits from lower oil prices were not passed to consumers and was also the reason consumer spending did not increase with low oil prices.

Underlying Problems

The slump in the Japanese economy has been attributed to different reasons but following are some of the key underlying problems in the Japanese economy that have made monetary and fiscal policies ineffective in Japan.

Japan has one of the most aged population of all the countries in the world. The median age is 46.1 Years and people aged 65 or older accounts for 26.7 percent of the total population. Aging population increases the government spending on the pension and healthcare of the aged people and it also decrease the available labor force. Moreover, the participation of women in the labor force is also very low which has caused further scarcity of Labor in Japan. Shortage of labor should result in increase in the wages but instead companies are outsourcing the manufacturing operation to offshore countries, which does not help the Japanese economy. Japan is also not very welcoming to the immigrants, which could be a potential solution to the labor shortage.