In Japan, the overall price level has declined since the bursting of a massive real estate and stock market bubble in the early 1990s. To put that in perspective, a college student n Japan today will have never experienced an extended period of rising prices.
Why is that a problem? More typically, people complain about inflation, so deflation should be welcome, right? There are at least two problems with this view. First, wages are also a price of sorts–the price of labor. And with deflation, nominal wages also tend to decline. Second, when expectations of deflation become entrenched in people’s minds, that can lead an economy into a deep hole, from which it can be difficult to emerge. Consumers, expecting prices to fall, will hold off on their purchases, especially for consumer durables. And businesses, seeing declining demand–and anticipating further price declines–will hold off on investing in new plant and equipment or hiring new workers. Sustained deflation may also reduce incentives to engage in R&D, or else tilt such activities toward cost savings and away from product innovation. This is precisely what we have observed in Japan for the two-plus decades that have come to be know as the country’s “Lost Decades.”
Since 2011, the Abe administration has sought to reverse this process, by raising inflation into positive territory and increasing domestic demand, turning a vicious cycle into a virtuous one. But despite some early success, this has proved difficult, in part because changing people’s mindsets is hard.. Despite the extremely accommodative monetary policy of the Bank of Japan, inflation remains close to zero and expectations remain well below the BoJ’s target inflation rate of 2 percent. Businesses have been reluctant to raise prices, knowing that consumers have become extremely price sensitive after decades of falling prices. And when price have increased, these same businesses have been reluctant to raise wages or investment, in part reflecting fears that any gains will be temporary.
The attached video provides a really interesting example of this problem. In mid-March, a Japanese ice cream company, Akagi Gyunu (famous for its uniques flavors, such as spaghetti or potato stew!) announced its first price hike in 25 years, equivalent to less than a dime per cone. The increase was accompanied by this heart-felt apology video. While many of us might wish that companies in their countries would take a similarly socially-oriented position, the video can also be seen in a much less positive light–as a reflection of the challenges that Japan still faces in exiting deflation and its lost decades.