Why is deflation a bad thing for the Japanese economy?

Question

I'm picking a topic for a paper on Macroeconomics, and I've read a lot about the Japanese economy in the news recently. Unfortunately, these articles only tell me about the current situation, without giving me much background information.

Answer 1

First, deflation does NOT devalue the currency -- just the opposite, it makes the currency more valuable compared with other things.

Deflation means that prices are going down, and things will be cheaper in the future than they are today; it also means that cash itself becomes more valuable and is therefore a good investment. And those two factors cause problems.

Think about it: why would you buy things you don't absolutely need today, such as an iPod or a new car or extra clothes, when you know they'll be cheaper next month? It's like finding out there will be a big sale at your favorite store next week -- you won't buy stuff today, you'll wait to get the better deal later. Deflation causes this effect in the wider economy: people put off buying stuff becuase they know it'll only get cheaper if they wait ... and wait ... and wait. The result is a fall in consumer demand and slower or negative economic growth.

It's not just that growth numbers will look bad. What happens if you're a business and you realize your sales are falling, both from prices falling and from lack of demand? You lay people off. So deflation causes higher unemployment. High unemployment means people have less spending money -- which further reduces demand. Falling prices, lower demand, and unemployment all feed off each other and amplify each other -- it's a death spiral.

Meanwhile, falling prices and shrinking business means interest rates will fall. In Japan they literally fell to zero (actually negative). This harms investment: no one wants stocks because companies are doing poorly; no one wants bonds because interest rates they pay are near-zero and do not compensate for their risk. So it's best just to stash cash in your pillow case -- cash is the best investment. But this is bad for the economy because it means that the few companies out there willing to try to expand their business may find it hard to borrow money -- there is less capital available. So borrowing rates are low, but you can't get qualified for a loan. All and all deflation is absolutely a bad thing -- and actually Japan is lucky things didn't get worse for them.

Answer 2

In their particular case because of cross-share ownership. That's when two corporations own each other's stock and include it in their assets and net worth. Deflation causes these shares (and real estate) to go down in a spiral fashion - the owning company's shares go down when the owned shares go down, etc., because the owning company's shares are valued less when the stuff it owns becomes worth less. This would cause the risk-adverse investor to dump all Japanese equities if the trend were to accelerate, kind of like professional day traders dumping their long shares if the security breaks below the 10-day moving average, etc.

But like the first Baron Phillipe Rothschild said "I only buy when there's blood in the streets", when the dust settles it would be a good buying opportunity.

Answer 3

The main thing would be the lack of incentive to invest. With inflation present it is important to put your money to work, but with deflation there is value in just holding the currency.

However, I would say that deflation isn't really a bad thing. If it were, why would the japanese be doing it?

Answer 4

I think it Devalues their Yen. It can work good or bad. Good, as their products/exports become cheaper in the world market, similar to China. Bad, as it makes imports cost them more, hurting the consumers disposable income for foreign goods and reducing spending and Tax for Government expenditures.