Japanese deflation: Labouring the point
11 March 2010
Japan’s recovery continued to defy more pessimistic expectations in the final quarter of 2009, with the economy growing 0.9%Q/Q. Nevertheless, the level of output remained a huge 6% below its peak in early 2008, with the resulting excess capacity driving deflation to record levels on several measures.
A key channel through which spare capacity has added to deflation is the labour market, with Japanese companies slashing their employment costs over the past year. There were more than one million fewer workers in employment in December 2009 compared to one year earlier, while average labour earnings were about 6% lower. With their purchasing power cut, although households have upped spending on durable goods (e.g. cars) to take advantage of fiscal incentives, spending on other items has been cut back. As a result, prices have been pushed lower across an increasingly wide range of products. In January, the share of items in the CPI basket with prices lower than one year earlier had risen to two thirds (see chart), the highest for more than six years, while CPI on the ‘core core’ measure (excluding energy and food) remained at a record low of -1.2%.
Core CPI inflation and the share of items experiencing falling prices
*Percentage of items in the core CPI (excluding fresh food) basket that are above their level a year earlier.
Source: MIC and Daiwa Capital Markets Europe Ltd.
Recent data, however, suggest that the labour market has turned. January saw a surge in employment, which rose by more than half a million – the biggest single monthly rise for more than thirty-five years. Japanese companies also used their workforces more intensively, increasing working hours. And, thanks particularly to a rise in overtime pay, total labour earnings rose above their level of a year earlier for the first month in twenty. In addition, the sharp pick-up in corporate profits in the final quarter of 2009 reported last week means that labour’s share of income now appears to be back at a more sustainable level – about 65%. All told, these data suggest that Japan’s labour market adjustment is approaching its end. As such, provided growth is maintained, the coming year should therefore be accompanied by further increases in employment.
Labour share of income and employment DI
*Employment DI shows the net share of companies considering themselves to be carrying excessive labour.
Source: MoF, BoJ and DIR.
But further increases in employment will not overnight end the deflationary forces emanating from the labour market. There is a huge amount of slack to be absorbed before we will even begin to see upward pressure on wages. In particular, in January, there were also still more than one million fewer workers in employment compared to the pre-crisis peak, while the job-to-applicant ratio remained close to its record low. Unemployment remains well above most estimates of its long-run sustainable level (the so-called non-accelerating inflation rate of unemployment, or NAIRU).
Meanwhile, the full effects of the past cuts in household incomes have still yet fully to be felt. Surveys suggest that the past year’s sharp declines in wages have raised households’ expectations of future deflation, which by itself adds to deflationary pressures. So in the absence of a sudden surge in global commodity prices, we expect core CPI to oscillate around the -1% mark over coming months, and remain in negative territory at least into 2012. And therefore, while the recent news on Japan’s real economy has been brighter than expected, deflationary pressures look set to continue to dominate over the foreseeable future, providing support to those members of the Bank of Japan’s Policy Board who are reportedly calling for a further loosening of monetary policy.
Labour earnings and 'core core' CPI inflation
Source: MHLW and MIC
Chris Scicluna, Deputy Head of Economics
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