Why is deflation continuing in Europe and Japan?

Here is an update from Japan:

Four years after the Bank of Japan set a 2 percent inflation target, price gains may still be coming up short, according to a survey of economists by Bloomberg News.

Consumer prices will rise an average 1.4 percent the fiscal year through March 2017, after failing to reach 2 percent — stripped of fresh food and a sales-tax boost — in any of the years since the goal was set, the median of 16 estimates shows. Governor Haruhiko Kuroda wanted to get there in about two years when he unleashed his record stimulus plan in April 2013.

Here are further data points from Krugman about other locales.

I am not seeking (today) to argue about liquidity traps, credibility, and the like.  Clearly the Japanese central bank can influence inflation at least somewhat, and recall the BOE helped bring inflation in at over five percent but a few years ago.  The ECB really could do much more.  But my view is this:

1. Most countries have labor market incumbents with sweet real wage deals, deals which could not be renegotiated anew today because the world has seen a repricing of labor downwards for the wealthy countries.

2. Higher rates of price inflation would cut into those deals and thus high rates of price inflation are unpopular.  Voters don’t quite understand the monetary economics here, but they have a vague sense that “inflation screws them.”

3. We are no longer at the point where two percent inflation is easy to achieve in Europe or Japan.  Central banks are doubted.  To achieve two, they would have to shoot for four, and thus announce a target of four.  Few voters wish to hear this, and furthermore a credible stab at four percent inflation might in fact bring three percent inflation or maybe more.  A non-credible central bank can indeed still debase its currency, yet the achievable targets are given by lumpy notches, not a smooth sliding scale.  In the case of the eurozone, too high an inflation target is probably illegal as well, given the sole mandate of price stability.

4. We thus end up stuck having central banks which announce a target of two percent but undershoot it.

As for Japan, here is a clue from the same article:

While Kuroda’s campaign — which has seen the BOJ’s balance sheet dwarf that of counterparts relative to the size of the economy — has spurred bank lending to the biggest jump in two decades and seen the end of outright deflation, it has yet to spark pay rises big enough to secure the 2 percent CPI target.

“It’s necessary to create an environment where wages rise sustainably,” said Kinoshita…

This also helps explain why European QE would need to be shock and awe, why it won’t be, and why it won’t help that much after all, even though it is better than doing nothing.  Few governments wish to boast they are lowering the real wages of their employed middle class citizens more rapidly than would otherwise be the case.  Reaping some extra votes from the marginally unemployed is not going to swing the electoral calculus on that one.

Let’s not blame the policymaker or the journalist.  I blame the economists who promote the notion that higher rates of inflation will boost rather than erode real wages.  That’s going to leave policymakers — and voters — waiting for a long, long time.


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