Debate on Deflation in Japan #7

Comment on Katz' Rejoinder

Craig Freedman (Macquarie University, Australia)

Richard Katz emphasises that to deal with Japan's economic problems you need to develop a well thought out package and avoid implementing it piecemeal. I would certainly support such an approach. The real argument isn't then about how much harm current levels of deflation cause. We simply don't know. The question is whether deflation can be resolved as a separate issue. I doubt that it can be. Richard Katz seems positive that it cannot be. We both don't see attacking deflation alone as a sufficient first step.

Some Clarifications

1. My focus on asset deflation lay with the housing sector. I would agree with Richard Katz that broad attempts at Price Keeping Operations are not appropriate. But the housing sector with all its associated consumer durables has been moribund for a decade. There are ways to encourage the housing market. Tax and zoning regulations have had perverse effects on that market. Reforms would be helpful. Certainly, targeted tax relief for home-owners is possible as well. These could all ultimately boost consumer demand.
2. The lag problem with deflation is not only the problem that some costs are fixed and others may be sticky. I was referring to the fact that production itself takes time. Costs are committed in period one, but revenue from sales comes only in period two. Prices received are not those of period one, but period two. Margins are reduced by any subsequent deflation even if cost structures are flexible.
3. Much has been made of Japan's current excess capacity, but those figures can be misleading. How much of it is actually obsolete? Meaning, how much existing capacity should be replaced by more technologically advanced capacity and would be replaced, given a more buoyant investment climate? Moreover, excess capacity in some sectors does not necessarily mean that there are not potential opportunities in others. I am always leery of aggregate figures such as economy wide capacity use.

Japan currently has a political structure which is associated with a set of incentives that are not compatible with its current economic environment. Until Japan faces up to its underlying political problem, the economic problem will remain.