Japan Is Back. Is Inflation the Reason?
Deflation might be vanquished, but the payoff could be elusive
Deflation might be vanquished, but the payoff could be elusive
The Nikkei stock index recorded last week its first new high in 34 years, a fitting tribute to Japan’s re-emergence as a genuinely exciting economy.
It also comes amid mounting evidence that Japan has finally broken the hold of deflation. Inflation in January was 2.2%, the 22nd month above 2%. Wage growth has picked up too.
This appears to vindicate the economic consensus that deflation was a primary driver of Japan’s decades long malaise. But that conclusion might be premature. Proof of deflation’s harm has been elusive, and the benefits of low, positive inflation might be similarly subtle.
Consumers are often surprised to hear that deflation is supposed to be bad. In the U.S., where prices have risen steeply since 2021 , normal people, and even economists, wouldn’t object if they fell a bit.
The trouble arises when prices fall persistently, year in and year out, because wages, incomes and the prices of assets such as property tend to follow. Debtors struggle to repay loans and might slash spending or default, endangering the financial system. That is what happened in the U.S. when prices fell 27% from 1929 to 1933.
Even mild deflation can, in theory, inhibit growth. Central banks stimulate spending by lowering nominal interest rates below inflation to make the real—i.e., inflation-adjusted—cost of borrowing negative. That is almost impossible when inflation is itself negative.
Japan’s deflation began after its property and stock-market bubbles burst in the early 1990s. Ensuing losses at banks eroded their ability to lend. Inflation turned negative in 1999.
Western economists such as future Federal Reserve Chair Ben Bernanke argued that curing deflation was essential to restoring Japan’s economic health. The Bank of Japan agreed, at first half heartedly and then wholeheartedly.
It used zero, then negative, short-term interest rates. Next came purchases of short-term, then long-term, government securities. Finally, the BOJ even bought shares in companies with newly created money to stimulate spending and raise inflation.
The BOJ only succeeded in bringing inflation up to around zero. It took the global supply chain shocks of the pandemic to finally push underlying inflation to 2%, the bank’s target .
Japan’s 25 years of zero to negative inflation was accompanied by one of the rich world’s lowest growth rates. Japanese deflation became a cautionary tale for other countries, most recently China, where prices are currently falling .
Yet proving that deflation was behind Japan’s problems is maddeningly hard. Arguably, it was more symptom than cause.
In the early 1990s, working-age population growth turned negative. This happened just as Japan’s post-World War II phase of catching up to other developed nations ended. Meanwhile, industry began moving production to lower-wage countries.
All this, plus the banking crisis, put structural downward pressure on prices, wages and growth.
Adjusted for its shrinking population, however, Japan’s performance has been respectable. From 1991 to 2019, its output per hour worked rose 1.3% a year. This was slower than in the U.S. but comparable with Canada, France, Germany and Britain, and faster than Italy or Spain, according to the economists Jesús Fernández-Villaverde, Gustavo Ventura and Wen Yao.
Since 2019, output per working-age person rose 7% in the U.S., 5% in Japan, 2% in the eurozone and zero in Britain, by my calculations. (This might overstate Japan’s performance because many of its elderly still work.) As any visitor can attest, Japan remains a prosperous, harmonious and well-ordered place.
“Had you appointed me governor of the Bank of Japan for 25 years with all the power in the world, I don’t think I would have been able to do better,” said Fernández-Villaverde.
This doesn’t prove deflation was benign. Growth (and deflation) might have been worse without the BOJ’s herculean monetary efforts. And if inflation had been positive, growth might have been stronger.
Still, it raises an awkward question: If zero to negative inflation is so damaging, where is the evidence?
The harm might lie in subtle behavioural changes by investors, companies and the public. For example, in a market economy, changing relative prices and wages are critical signals for reallocating capital and labor from stagnant to growing sectors.
Relative prices changes are unusually rare in Japan, according to the University of Tokyo economist Tsutomu Watanabe. He has found that from 1995 through 2021, prices of more than half of products didn’t change at all from year to year. This wasn’t just because average inflation was lower; price changes deviated from the average much less than in other countries.
In a December speech, Bank of Japan Governor Kazuo Ueda said years of low to negative inflation led to a “status quo in wage- and price-setting behaviour,” so many prices and wages didn’t change. “The know-how for raising prices was thus lost,” he said.
The absence of this price-discovery function, Ueda contended, sapped productivity and dynamism.
Watanabe’s research shows that since January 2022, prices have been less sticky and more dispersed. Coincidentally, the Nikkei’s latest rally began a year later.
This in great part reflects the enthusiasm of foreign investors such as Warren Buffett , shareholder-friendly changes in corporate governance, and Japan’s importance as an alternative to China for high-end manufacturing and technology.
Inflation, though, might also be a factor, said Paul Sheard , a former vice chairman at S&P Global who has studied the Japanese economy for decades. He added that investors care about nominal, not real, stock prices, earnings, dividends and cash flow.
Higher inflation flatters all those metrics. That benefit might be neutralised by higher interest rates, but Japanese bond yields have risen less than expected inflation, so real yields are down to minus 0.6%.
So perhaps inflation is reviving businesses’ and investors’ animal spirits. Even so, growth last year was about the same as before the pandemic and turned slightly negative in the third and fourth quarters, producing a technical recession . What’s more, wages have lagged behind inflation, and Prime Minister Fumio Kishida ’s approval ratings have plummeted.
Japan might have prevailed in its war against deflation. But ordinary Japanese have yet to see a peace dividend.
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Amazon, Google, Microsoft and Meta pour billions into artificial intelligence, undeterred by DeepSeek’s rise
Tech giants projected tens of billions of dollars in increased investment this year and sent a stark message about their plans for AI: We’re just getting started.
The four biggest spenders on the data centers that power artificial-intelligence systems all said in recent days that they would jack up investments further in 2025 after record outlays last year. Microsoft , Google and Meta Platforms have projected combined capital expenditures of at least $215 billion for their current fiscal years, an annual increase of more than 45%.
Amazon.com didn’t provide a full-year estimate but indicated on Thursday that total capex across its businesses is on course to grow to more than $100 billion, and said most of the increase will be for AI.
Their comments in recent quarterly earnings reports showed the AI arms race is still gaining momentum despite investor anxiety over the impact of China’s DeepSeek and whether these big U.S. companies will sufficiently profit from their unprecedented spending spree.
Investors have been especially shaken that DeepSeek replicated much of the capability of leading American AI systems despite spending less money and using fewer and less-powerful chips, according to its Chinese developer. Leaders of the U.S. companies were unbowed , touting advances in their own technology and arguing that lower costs will make AI more affordable and grow the demand for their cloud computing services, which AI needs to operate.
“We think virtually every application that we know of today is going to be reinvented with AI inside of it,” Amazon Chief Executive Andy Jassy said on Thursday’s earnings call.
Here is a breakdown of each company’s plans:
Amazon said a measure of its capex that includes leased equipment rose to a record of about $26 billion in the final quarter of 2024 , driven by spending in its cloud-computing division on equipment for data centers that host AI applications. Executives projected it would maintain the fourth-quarter spending volume in 2025, meaning an annual total of more than $100 billion by that measure.
The company—which gets most of its revenue from e-commerce and most of its profit from cloud computing—also projected overall sales for the current quarter that missed analysts’ expectations. Its shares slid about 4% in after-hours trading Thursday. The stock rose more than 40% in 2024 and was up nearly 9% this year before its earnings report.
Jassy said AI has the potential to propel historic change and that Amazon wants to be a leader of that progress.
“AI represents for sure the biggest opportunity since cloud and probably the biggest technology shift and opportunity in business since the internet,” Jassy said.
Google shares are down about 7% since its earnings report Tuesday, which showed disappointing growth in its cloud-computing business. Still, parent-company Alphabet said it is accelerating investments in AI data centers as part of a surge in capital expenditures this year to about $75 billion, from $52.5 billion in 2024. The spending will go to infrastructure both for Google’s own use and for cloud-computing clients.
“I think part of the reason we are so excited about the AI opportunity is we know we can drive extraordinary use cases because the cost of actually using it is going to keep coming down,” said CEO Sundar Pichai .
AI is “as big as it comes, and that’s why you’re seeing us invest to meet that moment,” he said.
Microsoft has said it plans to spend $80 billion on AI data centers in the fiscal year ending in June, and that spending would grow further next year , albeit at a slower pace.
Chief Executive Satya Nadella said AI will become much more extensively used , which he said is good news. “As AI becomes more efficient and accessible, we will see exponentially more demand,” Nadella said.
Growth for Microsoft’s cloud-computing business in the latest quarter also disappointed investors, leaving its stock down about 6% since its earnings report last week.
Meta, too, outlined a sizable increase in its investments driven by AI, including $60 billion to $65 billion in planned capital expenditures this year, roughly 70% higher than analysts had projected. Shares in Meta are up about 5% since its earnings report last week.
CEO Mark Zuckerberg said investing vast sums will enable it to adjust the technology as AI advances.
“That’s generally an advantage that we’re now going to be able to provide a higher quality of service than others who don’t necessarily have the business model to support it on a sustainable basis,” he said.
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