Japan warns that deflation can drag on recovery

AP News
Posted: Nov 20, 2009 3:27 AM

Japan's government highlighted the danger of deflation for the first time in three years Friday, warning that falling prices and a further worsening of the labor market could drag on the weak recovery.

Meanwhile, the country's central bank, which kept its key interest rate on hold at 0.1 percent, took a slightly more upbeat view in its monthly assessment of the economy because of an improvement in exports and private consumption.

The mixed outlook comes at a crucial juncture for the world's second-largest economy. It expanded at a stronger-than-expected rate in the third quarter amid rising factory output but the job market remains tough and many companies have reported quarterly losses.

The Cabinet's statement about deflation, coming in its monthly economic report, is hardly a surprise as Japan's consumer price index has been declining for months now.

But it shows that Japan's leaders are clearly worried about the trend. Falling prices, which plagued Japan during its "Lost Decade" in the 1990s, may sound like a good thing, but deflation can hamper economic growth by depressing company profits, lead to wage cuts and cause consumers to postpone purchases. It can also increase debt burdens.

"If consumers expect prices to fall further, they will stop spending and try to save. That's the biggest worry," said Hiromichi Shirakawa, chief Japan economist at Credit Suisse. "That would invite further deflationary pressure. That would have a knock-on effect on companies, on the government and everywhere."

It was the first time since August 2006 that the Cabinet report identified deflation as a problem.

Overall, the report said that while the economy has been "picking up, it is short of autonomous factors and remains in a difficult situation such as a high unemployment rate." The jobless rate has retreated from a record 5.7 percent in July to 5.3 percent in September _ still high by Japanese standards.

Japanese companies, bound by tighter labor laws and the tradition of lifetime employment, have responded to the slump by cutting wages rather than firing workers outright. American companies, Shirakawa pointed out, have done the opposite _ fired workers while keeping wages stable. The U.S. jobless rate is at 10.2 percent.

Finance Minister Hirohisa Fujii voiced grave concern over falling prices, saying that addressing deflation is "a very important point" in managing the economy, according to Kyodo News agency.

Shirakawa of Credit Suisse said the government's concerns about deflation may reflect the worry that falling prices mean lower tax revenues _ already a problem with Japan's rapidly aging population.

The Bank of Japan seemed to be less concerned about deflation and economy in general.

It said the decline in the consumer price index _ which fell 2.3 percent in September _ remained stable and was likely to moderate as the impact from oil prices fades.

The central bank, which was widely expected to keep its benchmark rate unchanged, upgraded its economic assessment for the third straight month, saying government policy measures have lifted consumption. It projected the pace of Japan's recovery is likely to remain moderate until around the middle of the fiscal 2010.

The reports came on the heels of figures Monday showing that Japan's economy grew at an annualized pace of 4.8 percent in the July-September period. Industrial production has also risen for seven straight months and the decline in exports has shown signs of easing.

Japan's benchmark Nikkei 225 sank 0.5 percent to a four-month low of 9,497.68.