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Article Abstract:

Japan faces a liquidity trap with problems arising from deflation, after pursuing price stability. The Japanese consumer price index dropped by 0.1% for the year to Jul 1999, but official figures do not take into account a move to discount stores, so overstate inflation. Japanese deflation is linked to excess capacity and weak demand rather than productivity rises. Interest rate rises were used to reduce land and stock prices, and stock prices dropped first. Land prices still rose, so interest rates were raised to 6% in 1990. A drop in asset prices led to a bad debt problem which hit banks.

Japan

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The new danger

Article Abstract:

There is a danger that deflation could become a problem, and it is one that central banks should take as seriously as risks from inflation. Deflation has already affected Japan and elsewhere in Asia, while inflation is close to zero in much of Europe. Weak demand and excess capacity could lead to more serious problems from deflation. This risk means that western monetary policy could be too tight. The European Central Bank and the Bank of Japan fear loss of credibility if they loosen monetary policy, but their credibility would be affected if deflation were to become a problem.

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