Inflation in Japan

As currency trading is simply the assessment of relative inflation rates and a given currency’s supplydemand balance, any signal that a central bank is trying to create more inflation is of the utmost importance.

All else held equal, we should presume expected inflation can be increased in Japan only through excess creation of yen. As “excess” is a relative and not an absolute term, how do we know excess yen have been created? The answer, quite simply, is when short-term interest rates fall, either the yield curve steepens, the currency falls or some combination thereof. In the case of the yen, this has been happening for years and has created a global liquidity engine called the yen carry trade (see “Looking at the yen carry trade,” Currency Trader, June 2007).

Let’s step back and take a long-term look at inflation in Japan. Given the outsized role of the Tokyo region in the nation’s economy, we should compare both the general CPI and Tokyo’s CPI. As is often the case with different inflation measures, we can easily lose the forest for the trees. Over time, the general and Tokyo-region CPI measures are very similar. The year-over-year changes for the general CPI first turned negative in October 1986; the year-over-year Tokyo-region CPI first went negative in January 1987. If consumer inflation had been a real problem in Japan in the mid- 1970s, the BOJ broke it successfully — and to the extent that stable, near-zero or negative inflation in Japanese consumer prices has been a fact of life in Japan since the second Reagan administration.