Japanese deflation, unknown unknowns and plain old rain

In a speech on Wednesday, Masaaki Shirakawa, governor of the Bank of Japan, offered a concise defence of the central bank’s calm response to the return of deflation. He cites Japan’s experience in the first half of this decade when “While there were many arguments about deflation at that time, eventually Japan’s economy started to recover amid the continued modest decline in prices”, adding that this “has been a puzzle to one who worries about deflation”.

Mr Shirakawa’s suggested explanation revolves around the relative mildness of the deflationary pressures (compared with those of the 1930s) and BoJ’s success in preventing financial sector instability. He also notes that Japan’s current consumer price deflation — which hit a record 2.4 per cent year-on-year in August — will ease as the impact of energy price falls works through. So the main thing to worry about is not so much falling prices, but signs that deflationary expectations are affecting the plans of companies and consumers — and these are so far lacking. The result is that the BoJ reckons that, “at present, it is unlikely that the decline in prices will induce downward pressure on economic activity”.

With the BoJ forecasting that prices will fall through fiscal 2011, this will not assuage fears that another extended bout of deflation will make it harder to achieve the sustainable growth Japan needs to dig itself out of its fiscal hole and make up the damage inflicted by the country’s recent brutal recession.

To sell his message, the somewhat staid Mr Shirakawa might be wise to learn a few rhetorical tricks from his deputy governor, Kiyohiko Nishimura, who used very location-appropriate language in remarks in Florida earlier this week. Mr Nishimura sounded almost Rumsfeldian in explaining that central bank unconventional action had been needed to calm financial markets’ fears of “unknown unknowns”, and he defended central banks’ attempts to exit from their emergency measures in terms listeners in the disaster-prone southern state would surely understand.

“Free shelters should be provided against a hurricane, but there should be no free umbrella against plain old rain,” he said. “[As] the immediate threat subsides and the hurricane shelters are removed, nobody assumes that that is the end of public efforts to rebuild the devastated community”.

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