Inflation or stagflation

Concerns about inflation and the overheating economy due to the expansionary fiscal policy under the US Biden administration have taken a breather, partly due to the re-expansion of the new coronavirus infection arising from the spread of the Delta variant (identified in India). The long-term interest rates have also regained stability.

Olivier Blanchard, Senior Fellow of the Peterson Institute for International Economics (PIIE), talked at the Bank of Japan International Conference held in May that long-term real interest rates have been declining for a very long time since the Black Death in the 14th century. He put emphasis on the importance of fiscal expansion. Even as stock prices continue to hit highs and business sentiment continues to improve, the bond market sees rapid growth and rising inflation as transient, signaling a persistent stagnation after COVID-19.

The infection of delta variant of COVID-19 has spread not only to Asia and Europe, but also to the United States, where about 50% of the total population has been vaccinated. It is estimated that the number of new infections per day in the United States will reach 300,000 at the end of summer.

The UK, which has advanced in vaccination, will lift the restriction measures and aim for “live with COVID-19”, but other European countries will be forced to strengthen the restriction measures again. There is also data that the duration of the vaccine effect is about half a year in the case of delta variant. The third inoculation will spread.

China is moving to tighten regulations on big tech companies amid economic slowdown. If they are separated from the world’s capital markets, China will lose the “golden eggs” needed for dynamic growth.

Even if there is consensus in the market that inflation is temporary, there are divergent views on the duration and the size of rate of increase. Crude oil prices are hovering in the $70 range per barrel, but some say they will rise to around $80-100 by the end of the year due to the maintenance of a coordinated production cut and increased demand for gasoline.

Japan, which has put Tokyo and other prefectures under its fourth COVID-19 state of emergency, made a huge supplementary budget in the fiscal year 2020, but 30 trillion yen was carried over to the next fiscal year; it implies that Japan is far from overheating economy. The current state of the economy is similar to the period until around the summer of 2008, when inflation emerged under recession (stagflation). At that time, the crude oil price was $140, and the inflation rate reached 2%, partly due to the continued depreciation of the yen. However, as income flowed overseas due to the deterioration of the terms of trade, profits were compressed and the economy fell into recession, and no one was pleased with the achievement of the 2% inflation target.

Japan’s per capita labor productivity was overtaken by South Korea and Turkey in 2019. Since the mid-1990s, when Japan fell into a secular stagnation, real wages have been flat, partly due to the outflow of income overseas; real wage increases have remained below the low growth in labor productivity.

The nominal effective exchange rate of the yen is at the same depreciation level as 2007-2008, and the real effective rate is at the level of the mid-1970s. The Bank of Japan has raised its inflation outlook for the fiscal year 2021 from 0.1% to 0.6%. The outflow of income overseas currently reaches 2% to 3% of the gross domestic product (GDP).

“Beggar-thy-neighbor policy” aims at improving the economic condition of one’s own country at the expense of another country. If the outflow of income to overseas exceeds the export expansion effect stemming from the depreciation of the yen, Japan will unintentionally implement “beggar-thyself policy” under monetary expansion, instead of the beggar-thy-neighbor.

(The english translation of the article was published in the Nikkei morning edition 2021/8/6.)