Inflation is a lot lower in Japan than first thought

Inflation is a lot lower in Japan than first thought
Japan's economy
Adjusting the rear-view mirror
Aug 31st 2006From The Economist print edition

ONE of the most glaring mistakes in the recent history of central banking stemmed from a sound response to unsound numbers. The Federal Reserve let inflation get out of hand in the 1970s, because it thought there was more slack in the economy than there turned out to be. A big revision of Japan's inflation figures last week suggests its central bankers may be making the opposite mistake.
The Bank of Japan (BoJ), along with everyone else, had been under the impression that the country escaped deflation late last year, and that consumer prices, excluding fresh food, were now rising at the heady annual rate of 0.6%. Having raised interest rates from the floor in July, the BoJ was expected to do so again this year.
Not any more. Last week, the islands' number-crunchers carried out their five-yearly overhaul of the inflation figures. The new numbers use a more recent “base year” (2005, not 2000), and track the cost of a more up-do-date basket of 584 goods. Hijiki, an edible brown seaweed, is in; “standard” rice is out; doughnuts are included, norimaki sushi tossed aside; fees for dancing school will be counted, those for dressmaking school will not.


This reshuffling of the statistician's shopping basket has rewritten recent history (see chart). Japan, it now seems, did not escape deflation definitively until July, when the core annual inflation rate reached 0.2% for only the second month in a row. As Richard Jerram, of Macquarie Research in Tokyo, puts it “price pressures today are where the BoJ thought they were six months ago.” With hindsight, July's rate hike looks premature and there may not be another one this year. The currency markets, at least, do not seem to expect one: this week traders demanded more than 150 yen for a euro, the worst rate since the single currency was created.
Still, Mr Jerram finds a silver lining in this statistical cloud of confusion. The disturbing lack of inflationary pressure suggests that the economy is more productive than its doubters suggest. And the economy seems to be coping surprisingly well with real interest rates that are, thanks to lower inflation, 0.5 percentage points higher than the BoJ intended. Such optimism drew strength from unemployment's fall to 4.1% in July, resuming a downward drift. There are now 1.09 jobs for every applicant at Japan's government-run employment agencies, the highest ratio since 1992.
America's statisticians have also been unsettling its central bankers. According to revised figures released this week, the economy grew a little more quickly in the second quarter than first thought, expanding at an annual pace of 2.9%, not 2.5%.
A day earlier the Federal Reserve released the minutes of its most recent rate-setting meeting, held on August 8th. At that meeting, the central bankers decided to sit on their hands, leaving interest rates at 5.25%. But not, the minutes reveal, before wringing those hands thoroughly over some more statistical revisionism.

The Fed's committee members are confident the economy will continue to grow in line with its sustainable long-run rate, more or less (probably less). But after the statisticians' yearly overhaul of the country's accounts in July, they are no longer sure what that sustainable rate is. The new figures suggest that America's workers are less productive and better compensated, than first thought. As a result, unit labour costs are higher and the economy will have to lose more steam than the Fed had hoped before price pressures subside.
These second takes on old numbers have left central bankers in Washington and Tokyo in an awkward limbo. What to do? Wait for fresh numbers of course! The Fed's pause will give it a chance to “accumulate more information”, the minutes said. The BoJ, on the other hand, seems to be waiting for October's Tankan survey of businesses before deciding what steps to take next. When the facts change, central bankers do not necessarily change their minds. They just wait for the facts to change again.

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