Expert Commentary

The Zero Era

This excerpt was originally published in Roger Bootle's The Death of Inflation -- Surviving & Thriving in the Zero Era, pages 2-5, London: Nicholas Brealey Publishing Ltd, 1996.

Imagine a world without perpetual inflation: prices in the shops falling in some years, rising in others; pay rising by 2 or 3% in the good years, static or falling in the bad ones; house prices as likely to fall as to rise; interest rates fluctuating in the range 2-4%.

Is this a purely imaginary world? No. It is the way things were most of the time before the onset of perpetually rising prices in the years after the Second World War. And it is the world to which I believe the countries of the west are gradually returning.

Inflation is a process of continually rising prices, implying a continually falling value of money. Acceptance of this process is ingrained in our habits of thought and action. Anyone born in the last 60 years has known nothing else but prices continually rising, and it is natural for people to assume that the future is going to be similar to the recent past. Sometimes, though, this assumption can be dangerously off beam. It was wrong to think that the 1970s were going to be like the 1960s, just as it had been wrong to think that the years after the Second World War would be like the 1930s. Sometimes history reaches a breakpoint. It is at a breakpoint now.

East and West

It is already plain that there has been a dramatic change in the inflationary environment. In Japan, it is painfully evident. In 1995, far from the threat of inflation, it was fear of deflation that kept the Japanese authorities awake at night. For many prices had already fallen. The Japanese have a marvelous expression for it: kakadu hakai or 'price destruction'.

The pricking of the so-called 'bubble economy' by the imposition of high interest rates in 1990-91 (later reinforced by the effects of a super-strong exchange rate for the yen) saw asset prices crumble. Land prices fell continuously from 1991 to 1996, while the Tokyo stockmarket index fell from a high of nearly 40,000 in 1990 to a low of just under 15,000 in mid-1995, before recovering to stand at just over 18,000 in February 1997. In December 1996 wholesale prices were some 7% lower than they had been in 1990.

Consumer price inflation also fell dramatically. Indeed, in 1995, despite an inefficient and price-sluggish distribution system, prices in the shops barely rose at all. In fact, in November 1995 the annual rate of inflation was minus 1/2%. It subsequently picked up -- the rate for 1996 as a whole was 0.1%. But if the distribution system had passed on lower costs fully to the consumer, there is no doubt that we would already have witnessed sustained consumer price deflation in Japan. This is not another example of innate Japanese superiority, for in the 1960s and 1970s Japan suffered from high inflation as badly as did the countries of Europe and North America. It is only recently that Japan has been transformed from a high inflation economy into an economy hovering on the brink of deflation.

But far from bringing on the state of nirvana which the collapse of inflation is so often alleged to induce, this fall in inflation brought the Japanese economy closer to disaster, with the financial system in desperate straits, the property market shell-shocked, the stockmarket hovering on the brink of meltdown, and the banking system held together on a wing and a prayer. Moreover, having cut interest rates to 1/2%, as far as traditional monetary policy is concerned, by the end of 1995 the authorities had more or less reached the end of the line.

To make matters worse, although they launched several substantial packages of increased spending and tax reductions to boost demand (the policy advocated by followers of the great economist John Maynard Keynes), the authorities were concerned about using this standard remedy on a very large scale. They were worried by Japan's adverse long-term fiscal prospects due to its rapidly ageing population. Indeed, in 1997, taxes were set to rise. At least by the beginning of 1997, the economy was growing again, but no one could be confident that the crisis was over.3 Yet this is not a uniquely Japanese difficulty. Throughout the west, government debt levels pose a problem, even with very low inflation. If the economy tipped over into deflation, most western governments would probably feel constrained from adopting the Keynesian remedy.

Although we like to think that the economics of deflation are now so well understood that anything like a repeat of the 1930s is unthinkable, the Japanese experience is salutary. It shows that the dangers of deflation are very far from being over.

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