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The World's Most Radical Experiment in Monetary Policy Isn't Working

The Wall Street Journal. logo The Wall Street Journal. 2/26/2017 John Lyons, Miho Inada
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During Japan’s go-go 1980s, Hiromi Shibata once blew a month’s salary on a cashmere coat, wore it a few times, then retired it. Today, her daughter’s idea of a shopping spree is scrounging through her mom’s closet in Shizuoka, a provincial capital.

“About a third of my wardrobe is hand-me-downs from my mom,” says 26-year-old Nanako Shibata, who lives in Tokyo. To save on the 112-mile trip home, she rides the bus instead of the speedy bullet train, once a symbol of Japan’s rise.

The U.S. appears to be leading other parts of the globe out of an extended era where central banks relied heavily on low and negative interest rates and stimulus to jump-start growth and keep prices from falling. The Federal Reserve has raised U.S. interest rates, and the European Central Bank is considering easing its stimulus.

Japan remains definitively stuck, despite a long and aggressive experiment with ultralow rates. A quarter-century after its property bubble burst, a penny-pinching generation has come of age knowing only economic malaise, stagnant wages and deflation—a condition where prices fall instead of rise.

The belief that deflation will continue has become so ingrained it has presented seemingly insurmountable challenges to monetary policy, a lesson for other countries that are traveling a similar path.

“It is hard to change the deflationary mind-set even with radical policies,” says Frederic Neumann, co-head of Asia economics for HSBC. “I would argue Japan will remain in its funk and will remain there for many years.”

Japan is nearly four years into a Central Bank stimulus effort involving printing trillions of yen and guiding interest rates into negative territory, perhaps the globe’s most aggressive such efforts under way. Bank of Japan governor Haruhiko Kuroda’s shock-and-awe stimulus, launched in April 2013, fizzled after a short-lived spurt of growth and rising prices. Japan fell back into deflation last year. More recently, the inflation rate has been bouncing around near zero.

In November, Mr. Kuroda postponed his goal of reaching 2% inflation, all but admitting he is out of ideas. He said in a series of speeches last year that an entrenched “deflationary mind-set” stifled hope that wages or prices will rise, limiting the impact of monetary policies such as negative rates. Mr. Kuroda declined to comment through a spokesman.

Japan’s inflation rate has ticked above zero in recent months, which economists attribute to the election of U.S. President Donald Trump, a stronger dollar and higher oil prices—not economic fundamentals in Japan. Few see Japan returning to robust growth and rising prices.

Deflation is bad for an economy because it undermines economic growth. Businesses earn less, so they invest less, cut wages and stop hiring. Amid the economic uncertainty, consumers stop spending, furthering the downward spiral.

The idea behind ultralow rates is that they jolt consumers and businesses into spending by kindling inflation. But Japan’s deflationary expectations have become so routine that consumers and businesses refrain from spending no matter how low the central bank goes. There is evidence, in fact, that rock-bottom rates are backfiring by frightening consumers into saving for perilous economic times, not spending.

In an era of central-bank improvisation, no other nation has pushed the envelope as much. The Bank of Japan was the first to lower its benchmark rate to near zero in 1999, long before Europe, the U.K. and the U.S. did so in response to the 2008 financial crisis. In 2001, Japan began flooding its financial system with cash to try to spur inflation and growth, a practice called quantitative easing that was later adopted in the West.

Mr. Kuroda in 2013 began pumping so much money into the financial system—eventually around $700 billion a year—that some investors worried hyperinflation or asset bubbles would form. That hasn’t happened. Last year, the Bank of Japan followed the European Central Bank in guiding rates into negative territory, a radical attempt to force banks to lend more money by making it costly if they don’t.

Japan’s predicament today was almost unthinkable during its 1980s boom, when Japanese tycoons bought trophy properties such as New York’s Rockefeller Center and Tokyo real-estate prices were the world’s highest. In 1989, Japan initiated interest-rate hikes that popped real-estate and stock-market bubbles.

Since then, annual growth has averaged less than 1% amid periodic recessions. Prices began falling in the late 1990s.

Japan’s economy dropped to the world’s third-largest after fast-growing China surpassed it as No. 2. The Nikkei stock-market average is around half its 1989 peak. Property prices have fallen broadly for a quarter of a century.

Frozen-dessert maker Akagi Nyugyo ran an apologetic advertisement last year after implementing a 9 cent increase, its first in 25 years. Japanese companies are sitting on nearly $2 trillion in cash, idle money that officials contend should be invested in Japan.

The deflationary landscape is deeply imprinted on the 20 million Japanese between ages 20 and 34 who grew up after prices started falling. Wage increases, rising stocks or banks that pay decent interest on deposits are all hypotheticals to them. They live in a world where anything they buy today might be had for less tomorrow. Their instinct is to do the safe thing and economize.

They reject the consumerism of their parents’ generation as excess. Some live with roommates in group homes, a new phenomenon for Japan, and dine on $3 beef bowls. If they spend on anything, it is travel. In a deflationary society, experiences don’t lose value, while anything you buy does.

Some older Japanese who knew the privations of the postwar years see a worrisome lack of ambition in younger people. Japan uses the term “neets” to describe young people “not in education, employment or training,” while “freeters” work unstable part-time or contract jobs. Japanese “parasite singles” never leave their parents’ home, and women complain about “herbivore men” uninterested in the opposite sex.

“Their problem is they are too comfortable,” says Heizo Takenaka, a former economy minister. “Their expectations are low. We wanted to own the excellent cars. But they don’t seem to want to.”

Many economists believed the Bank of Japan’s 2013 stimulus would be enough to jolt the nation out of its downward spiral of weak growth and falling prices. Mr. Kuroda and others in Prime Minister Shinzo Abe’s government point to an initial burst of inflation and growth as signs the stimulus will eventually work. Others say the monetary policies worked until they were undermined by a 2014 sales-tax increase.

A Bank of Japan survey in October found only 5% of respondents planned to spend more next year, while 48% intended to cut.

Keita Kameyama, a 30-year-old civil servant in Kagawa, a rural province, has been saving around 25% of his $40,000 salary each year to eventually marry his longtime girlfriend. He lives at home with his mother, drives an old Honda and rarely shops.

The central bank’s stimulus measures had no effect on Mr. Kameyama’s spending. He still salts away his money in plain-vanilla bank accounts. He fears Japan’s long stagnation will wipe out his pension, and worries he won’t have enough money to care for his mother—a growing concern in a country with twice as many people over 60 than between 20 and 34.

He sees bank accounts, which offer minuscule interest rates on deposits despite negative short-term rates, as the only way to save. Hyakujushi Bank, Ltd. the biggest in Kagawa, pays only 0.05% on deposits and has paid less than 1% since 1995.

“People in Kagawa love to save,” says Mr. Kameyama. “I have heard [the Bank of Japan] is trying very hard to get people to spend their money, but I don’t think I will be opening my wallet.”

Many young Japanese economize because they simply don’t have enough money. More are working low-paying and temporary jobs with no benefits.

“Companies aren’t growing, and they have aging workforces that they can’t fire,” says Takuji Okubo, an economist and founder of the Japan Macro Advisors research group. “So there’s no room to hire young people.”

Automobile, beer and cosmetics firms have slashed young-adult advertising and market to retirees instead, says Yohei Harada, head of the youth-marketing unit at Tokyo advertising agency Hakuhodo Inc. “The role of parents and children is getting reversed, where the parents from the bubble generation still act like children and want to buy the fancy car, while their children in the post-bubble generation worry about their parents’ spending,” he says.

Takashi Saito, a 33-year-old unmarried entrepreneur, was living in group apartment in Tokyo in 2015 when he decided to start a business. His idea: an online clothing-rental company for women who want a varied wardrobe but don’t want to pay for it. For $45 a month, clients rent three articles of clothing at a time, which they can return for others when they like.

Mr. Saito thought it would be easy to get a loan because Japan’s low-rate policies are meant to spur banks to lend more to small businesses. It wasn’t.

He asked Japan Finance Corp., a state-owned institution set up to lend to small businesses, for $200,000. After much haggling, he got less than $50,000. A year later, as the business grew, he asked for more. He was rejected. Japan Finance Corp. declined to comment.

Bank analysts say Japanese lenders have become more conservative, particularly with startup companies that have no collateral, because low rates cut into profits. In the 11-months after Japan’s rates went negative last year, Japan Finance Corp.’s loan portfolio shrank.

Mr. Saito raided savings, borrowed from family and is hoping for venture capital.

Japanese clothing brand Uniqlo became a hit in the deflation era, appealing to a nation of penny pinchers with inexpensive casual wear. But customers stopped buying Uniqlo after price increases in 2015, forcing the retailer to cut prices to win back sales.

Uniqlo founder Tadashi Yanai blames negative rates and other central bank policies, such as quantitative easing, for worrying consumers. “It’s anxiety about the future,” he said in an interview. “They have to stop negative rates. That’s idiotic.”

J.P. Morgan Chase & Co.’s Japan economist, Masaaki Kanno, says the deflation mind-set is entrenched because it is rational. With wages unchanged for 25 years, young adults don’t believe they will earn more in the future.

Some economists contend the government should try even more fiscal stimulus and monetary easing. Others argue the stimulus has already saddled Japan with so much debt—now 230% of gross domestic product—that it could end in an economic collapse.

Ms. Shibata, the Tokyo resident who raids her mother’s closet, recently cut her hours at a job-placement service to three days a week. To do so, she moved into an apartment that rents for half what she was paying. She has stopped shopping altogether. She sees no point in pouring her time into a career. She is pursuing contemporary dance instead.

“I think it’s not fair if I get consumed completely by a company,” says Ms. Shibata. “Nowadays, we can hardly expect a raise.”

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