2019-07-18

This article introduces Hideo Tamura’s warning that raising Japan’s consumption tax to 10 percent in October 2019 could push the economy back into deflation.
It examines Tamura’s direct appeal to Prime Minister Yukio Hatoyama for quantitative monetary easing, the Bank of Japan’s refusal to act under Governor Masaaki Shirakawa, and the effects of earlier tax increases on nominal GDP, prices, wages, and employment.

2019-07-18
The editorials and articles written by Hideo Tamura and Nobuhiko Sakai demonstrated that the Sankei Shimbun was, at that time, the highest-quality newspaper in Japan.
I would like to introduce to those who do not subscribe to the Sankei Shimbun an article by Hideo Tamura, one of the very few genuine economic journalists who has an economic analysis of his own rather than merely repeating what the Ministry of Finance says.
Summoning the Nightmare of Deflation!?
An Irresponsible Diet That Ignores the Consumption Tax Hike
The current ordinary session of the Diet has devoted itself to pursuing statistical misconduct by minor officials at the Ministry of Health, Labour and Welfare, while almost entirely ignoring the consumption tax increase scheduled for October, which will affect the entire national economy.
A consumption tax hike could summon the nightmare of deflation.
Is the absence of a serious debate not an abandonment of the government’s responsibility?
Speaking of a “nightmare,” Prime Minister Shinzo Abe used precisely that word at a recent Liberal Democratic Party convention to characterize the former Democratic Party of Japan government.
Before that, in his policy speech to the Diet, the prime minister had declared that the deflationary mindset was about to be eliminated.
With the understanding that the greatest nightmare experienced by the public during the Democratic Party government was the deflationary recession, he presumably wanted to emphasize that Abenomics was overcoming deflation.
According to news reports, rising labor and distribution costs were expected to bring price increases for milk, yogurt, cup noodles, highway bus fares, and other goods and services from that spring onward, as reported in the Sankei morning edition of the 18th.
Economics textbooks define deflation as a general and continuing decline in prices, but that definition does not necessarily correspond to people’s actual experience.
Even when prices are rising, deflationary pressure arises when wage increases fail to keep pace.
Because household finances do not improve, consumer demand declines.
Companies forced to sell at low prices become reluctant to raise wages.
Prices then begin to fall, pulling wages down with them.
That is the true nature of deflation.
When the situation worsens, wages fall even faster than prices.
A consumption tax increase is a policy through which the government deliberately exposes people’s lives to deflationary pressure.
It places an additional tax burden over virtually all goods and services at once.
In fiscal 1997, when the administration of Ryutaro Hashimoto raised the consumption tax rate from 3 percent to 5 percent, prices were forcibly pushed upward, but growth in nominal gross domestic product stopped.
Japan subsequently entered a long-term trend in which nominal GDP contracted faster than prices declined.
As described above, after the consumption tax increase, industries throughout the economy began reducing wages and employment.
A vicious cycle emerged in which a general fall in prices and a reduction in the income of the public proceeded simultaneously.
Consider the graph.
It compares the year-on-year rates of change in nominal GDP, the GDP deflator—which measures the overall price level of the economy—and the Bank of Japan’s supply of funds, known as the monetary base, from fiscal 2009, when the former Democratic Party government took office.
Under that government, Japan remained unable to escape the deflation that followed the Lehman shock.
When the Great East Japan Earthquake struck in March 2011, both GDP and prices fell into negative territory.
Looking back, the former Democratic Party government truly had no effective policy.
In early 2010, the author, together with the late economist Shuntaro Shishido, professor emeritus at the University of Tsukuba, and others, met directly with then Prime Minister Yukio Hatoyama after the Democratic Party had taken power.
They urged him to adopt quantitative expansion not only in fiscal policy but also in monetary policy.
Hatoyama listened while rolling his large eyes and agreed, saying, “Yes, monetary easing is important.”
The Bank of Japan, however, showed no sign of taking action.
Some time later, the author happened to meet former Prime Minister Hatoyama in a Diet conference room and questioned him about the matter.
Hatoyama replied quite casually, “I conveyed the request to the Bank of Japan through the Chief Cabinet Secretary, but it was rejected.”
Masaaki Shirakawa, then governor of the Bank of Japan, appeared to embody the so-called “Bank of Japan theory” that deflation could not be corrected through monetary policy.
The Shirakawa-led Bank of Japan increased the money supply only briefly after the Great East Japan Earthquake.
It then returned to monetary tightening by withdrawing funds and thereby intensified deflation.
Ministry of Finance bureaucrats used the inexperienced former Democratic Party government as a stepping stone toward a major consumption tax increase.
Then Prime Minister Yoshihiko Noda followed their direction and concluded a three-party agreement among the Democratic Party, the Liberal Democratic Party, and Komeito to raise the consumption tax.
The agreement called for the rate to be raised in two stages, first by 3 percentage points and then by another 2 percentage points.
Within the ministry, some officials reportedly argued for caution, saying that even European countries avoided increases of such magnitude because of concerns about the adverse effects on the economy and instead limited themselves to smaller increments.
Senior officials dismissed that view, declaring that the Democratic Party government presented a once-in-a-lifetime opportunity.
The former Democratic Party, which allowed deflation to continue and committed itself to a consumption tax increase that would worsen chronic deflation, suffered a crushing defeat in the House of Representatives election against Abe’s Liberal Democratic Party, which advocated an end to deflation and bold monetary easing.
The Abe administration expanded the economy through Abenomics, centered on monetary easing of an unprecedented scale.
However, it suffered a major setback when the consumption tax rate was raised to 8 percent in fiscal 2014.
After both the GDP deflator and GDP fell sharply, the economy recovered somewhat through export-led growth.
Nevertheless, in the second half of the previous year, nominal GDP recorded year-on-year declines for two consecutive quarters.
Japan could no longer rely confidently on external demand.
Economic expansion in the United States had stalled, while the slowdown in the Chinese economy had become increasingly evident since the second half of the previous year.
The Trump administration’s punitive tariffs against China were likely to accelerate China’s economic deterioration.
If Prime Minister Abe proceeded with the consumption tax increase to 10 percent despite these circumstances, the word “nightmare” could return like a boomerang and strike him.