It looks like Japan’s last couple ‘lost’ decades is going to extend to the present decade as well. Many seem to harbor the notion that central banks around the world are God’s Messiahs, who whiff the magic wand of monetary and/or fiscal policy and lo! There’s light! Wish things worked that way in reality.

In an interim assessment of the Outlook for Economy Activity and Prices, the Japanese central bank’s median forecast for core Consumer Price Inflation was: 2009 = -1.5%, 2010 = -0.5% and 2011 = -0.2%. For an economy that has been mired in deflation, the central bank has dutifully done its bit, providing liquidity. So why hasn’t inflation picked up? Surely all this liquidity glut should push inflation up?

The problem lies in the fact that a central bank can only encourage but not compel banks to lend. Irritatingly the harder the central bank pushes the rope, the slacker the rope gets. On the other hand, faced with an uncertain economy and a default-rich environment, banks are reluctant to lend to consumers, who in turn are hesitant to borrow given the same environment!

So even as stock of money (M1, M2, M3) continue to log YoY growth of 1-3% each month, outstanding loans continue to decline at YoY rates of >1% each month! The Bank of Japan mentioned recently that they may open their wallets some more. Hmm…

Inflation anyone?


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