Wednesday, 5 November 2014

Japan needs inflation?

Krugman says, “Right now, Japan is struggling to escape from a deflationary trap; it desperately needs to convince the private sector that from here on out prices will rise, so that sitting on cash is a bad idea and debt won’t be so much of a burden..”
Problem there is that consumers might be aiming for some specific stockpile of cash (in real terms), in which case they would react to rising prices by SAVING more. And given the Japanese propensity for saving, the latter is far from impossible.
As for “debt won’t be so much of a burden”, that cuts two ways. Yes, inflation makes debtors better off, but it makes creditors WORSE OFF. The two opposing effects there might cancel out.
A more certain way to induce spending is simply to have the state create money and spend it (and/or cut taxes). The spending raises employment. Plus household’s stock of cash rises in real terms both as a result of the latter spending and as a result of any tax cuts. When households find an extra $5,000 in their bank accounts (revelation of the century this) a fair proportion of that extra money will be spent. As to the effects Krugman alludes to, they might work or might not. Under the above “create money and spend it” policy, it doesn’t matter if the Krugman effects are significant or not.

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