Question

Question 10 Why is Japan finding it so difficult to raise inflation to its 2 per cent target? Why has its monetary policy become so extreme?

(1) Despite the efforts of the Bank of Japan, year-on-year inflation (without fresh food and energy) is only 0.2 per cent. Yet nearly five years have passed since, in concert with the government, the BoJ declared its intention to hit a target of 2 per cent inflation. Then, in April 2013, it announced “quantitative and qualitative easing”, which unleashed a huge expansion of its balance sheet. In January 2016, it announced a modestly negative rate on new bank reserves. It has even said that it would continue to buy assets until inflation “exceeds the price stability target of 2 per cent and stays above the target in a stable manner”. Yet even all this has failed.

(2) This is not because these measures — supported by expansionary supplementary budgets — have failed to stimulate the economy. The rate of unemployment has fallen to 2.8 per cent, a level last seen in 1994. The Organisation for Economic Co-operation and Development has forecast growth at 1.5 per cent this year, up from 1 per cent in 2016, and it expects growth of 1.2 per cent and 1 per cent, in 2018 and 2019 respectively, both slightly above potential. Moreover, gross domestic product per head grew at close to the average rate of OECD members between 2012 and 2016. Yet the anchoring of inflation expectations appears so strong — at about zero in Japan — that wages and prices remain sticky. Analyze the above passage.

Answer 1

Japan is finding it extremely difficult to raise the inflation to its 2 per cent target. This is mainly because inflation expectations are not changing because people are not expecting the policy decisions to be credible. Since inflation expectations are not changing and thus wages and price are remaining sticky there is no impact on the inflation rate in the economy. All other variables in the economy are changing except the inflation rate because expectations play an important role in changing inflation.