This item is helpful and by been about Japan, we are spared parochialconsiderations. The Canadian experience, now a couple of decades oldhas been excellent. It slowly eats away the cash bubble produced byinterest and over the same types of time frames. I actually thinkthat two percent happens to be the sweet spot.
The difference between the Canadian experience and the Japaneseexperience argues just this. I also think that any higher will bealso be counter productive and agitation to go higher needs to beignored. Whether we like it or not we have entered a low interestworld that needs to be sensibly sustained even as it reprices assetsupward
Once this form of inflation stability is secured, it is inevitablethat housing in the USA will reprice upward to around a $300,000average close to the present average new house price. Once again,the home becomes a solid store of value. Recall that two percentbuilt in? It means a well priced housing buy must be worth halfagain as much in thirty years or so which is the actual planningcycle of the consumer of housing.
It is not fabulous, but it is good enough to also mitigate local weakspots. The net result is that owners always come out whole unlessthey were really unlucky. That is what really matters after all. Profits are good for bragging rights but remaining whole while livingwell is the real agenda of everyone.
A yen for inflation
William Watson | Jan23, 2013
http://opinion.financialpost.com/2013/01/23/william-watson-a-yen-for-inflation/
John Crow’s 2%target is adopted by Japan as well as U.S.
It begins to appearthe real Canadian superstar central banker of the lastquarter-century was, not Mark Carney, but John Crow. On Monday yetanother big country adopted Crow’s strategy of a 2% target forinflation, this time Japan. The U.S., the biggest convert of all,came over last year. Truth be told, we weren’t the first toadopt inflation targeting as a central bank strategy. New Zealandpreceded us by two years and went a percentage point lower. But, ledby Crow, who took all the heat at the new monetary regime’s outsetand was a one-term bank governor as a result, we were in at thestart.
One difference betweenus and the Japanese is that when we adopted inflation targeting, 2%was an ambitious goal. At the time, our inflation rate was over 5%.In Japan, by contrast, the consumer price index is basicallyconstant. It was 100 in 2005 and 98.8 last November, which is not somuch deflation as no-flation. What fun awaits the Bank of Japan! As asect, central bankers are trained from their earliest days thatinflation is anathema. Now Japan’s have been tasked to deliberatelycreate some. It’s like preachers being required to cavort withfloozies.
Why would a countrywith almost perfect price stability opt instead for inflation?One problem is that consumer price indexes are always biasedupward: In real life, when the price of a good rises, peoplesubstitute away from it. The CPI assumes, by contrast, that theirspending patterns stay unchanged. Studies suggest the bias is half tothree-quarters of a percentage point, so unless you’ve got alittle bit of CPI inflation, you really have deflation. That mayor may not be bad. Views differ. But it’s not strictly pricestability.
But why take inflationbeyond the half to three-quarters per cent a year that would be trueprice stability? The idea is to fix the “problem” of the ZeroLower Bound.
With zero inflation,cash pays zero per cent real interest. Cash always pays nominalinterest, i.e., it doesn’t pay interest. So the real interest itpays depends on the inflation rate.
Deflation givescash a positive return that’s more or less risk-free (unlessyou’re holding your cash late at night in clear plastic bags in arough part of town). Positive risk-free real interest on cash maydiscourage investment in anything else that does involve risk. If youwant to see increased investment in real estate or capital equipmentor individual learning, positive real returns to cash don’t help.
By contrast, inflationgives cash a negative real return. Two per cent a year may seemtrivial — it did when countries had become used to 5% or 6% or evenhigher — but with inflation at 2%, $100 turns itself into $82after 10 years and $67 after 20 years, not at all trivial if you’rethinking long term, which is how we want people to think.
With inflationdrip-dripping away at the value of cash in this way, people may bemore willing to consider other types of investments, including thebricks-and-mortar, nuts-and-bolts, silicon-and-bytes kind that createjobs.
Trouble is, oncepeople know inflation is coming, they’ll act to offset it. All elseequal, 2% inflation would reduce all real interest rates by 2% andthat would make real, employment-generating investment easier. But ofcourse all else won’t be equal. If everyone knows inflation will be2%, everyone lending money will ask for an extra 2% to preserve thereal return to their investment. Nominal rates change, real ratesdon’t.
The only investmentsfor which compensating adjustments aren’t possible are thosealready made. If you lent money at 5% when you thought there wouldn’tbe any inflation, you were counting on a 5% real return. Now thecentral bank decides it prefers 2% inflation, so your real returnfalls to three. You’re out 2% real. Too bad, so sad!
Do such windfalltransfers from lenders to borrowers help the economy? Maybe in theshort run. One of the biggest borrowers of all is Japan’sgovernment, which has debts approaching 200% of GDP. Paul Krugmanrecently wrote approvingly about higher Japanese inflation “helpingto inflate away part of the government’s debt,” which itcertainly will do.
But will the effectsbe all good? What happens to lending in the long term? People lendexpecting one inflation regime and then the government announces anew regime? True, the government never guaranteed it wouldn’t. Thelenders lent with their eyes open. Still, it’s a kind of swindle,isn’t it?
The government nowsays it won’t swindle again. Two per cent will be the rate for thelong term. But what’s to prevent it, three years from now, fromgoing to 4% — as in fact several prominent economists havesuggested the U.S. should do in order to deal with its own Zero LowerBound?
Greater anxiety aboutthe likelihood of making a given rate of return on money lent isn’tthe worst disaster imaginable. But will a reputation for policyduplicity really secure Japan’s future?
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