Japan has been dogged by deflation for much of the past two decades. In a deflationary cycle, suppliers cut the costs of their goods in order to attract customers, but over the longer term this has the effect of encouraging consumers to delay significant purchases against the knowledge that they will cost less at a future date when they do by the product. This has the effect of weakening domestic demand which is a key element of any economy. Introducing a low, stable level of inflation into the Japanese economy has been a key component of Shinzo Abe’s government policy and the Bank of Japan is targeting a level of 2%.
Part of the strategy to boost inflation and the exchequer’s receipts was to increase sales tax which went up from 5% to 8% in April and will rise to 10% in October next year, the April hike was the first rise in 17 years.
Data for May shows that consumer price inflation was running at 3.4%. The fact that this “runaway inflation” figure was the highest level seen in 32 years highlights the problem that Japan has endured with deflation – it is a very modest figure indeed. Inflation in Japan has now been increasing for twelve months. It is hoped that by putting an end to deflation that Japanese consumer demand will be bolstered since there will be an incentive to make purchases promptly as prices will be higher at a future date.
Japan is facing a demographic time bomb with an ageing population and falling birth rate. Social security costs will inevitably rise as an increasingly elderly population needs healthcare and fewer workers are actively engaged in the economy to meet the costs. Japan already has the worst debt to GDP ratio of any industrialised nation at 230% of GDP. Whilst the increased revenue from the sales tax will be welcome, it will do nothing to address the problem of Japan’s existing public debt.