No Fear

Japan's recent bout of inflation has come as a culture shock. A generation of Japanese has seen nothing but ultra-stable—or even falling—prices. In June, Japan's inflation rate hit 1.9 percent a year, the highest since 1998, before the country entered its long deflationary spiral. Heizo Takenaka, director of the Global Security Research Institute at Keio University and Japan's former economics minister, talked with NEWSWEEK's Stefan Theil about why Japan isn't quite as worried as the rest of the world. Excerpts:

NEWSWEEK The whole world seems to worry about rising inflation. Not Japan?
Heizo Takenaka: For Japan the inflation problem is not yet so serious. In June, the consumer price index was up 1.9 percent over the past 12 months. Compared with the 5 percent rise in the United States over the same period, that is still quite low. Japan's core [Consumer Price Index], which excludes energy and foodstuffs, is barely positive, at .1 percent. One could argue that Japan is still not very far from its deflationary trend.

So Japan isn't in any danger?
One could say the Japanese economy is one that does not fear inflation. It is clear that Japan is not in a situation requiring a quick interest-rate hike to fight inflation.

Prices are rising for gas and food, but elsewhere there's deflation. What does that mean for Japanese consumers?
The problem for Japan is the so-called price gap. Basic consumer goods are included in the inflationary trend, but there are other goods and services whose prices are still declining. Most importantly, wages are part of the deflationary trend—nominal wages have been flat or going down. This puts extra pressures on people's daily lives and is a potential threat to social stability.

What does the Japanese government need to do?
Japanese monetary policy has not been very good. Japan's problem in the past has been deflation, which is comparatively basic. The Bank of Japan could have resolved that problem faster by applying a normal policy of monetary supply expansion, but it squeezed the money supply too much. As a result, Japan had its Lost Decade. The situation today—inflation backed by a global uptrend in commodity prices—requires a much more sophisticated set of policy measures. After their inability to solve the earlier basic problem, one is left with doubts about the ability of the Japanese government and the Bank of Japan to solve today's more difficult and complex problem.

Can the rest of the world learn anything from Japan's deflation and what you describe as the poor reaction of the government and central bank?
Monetary policy and bank supervision are the two most important instruments of the central bank. The Bank of Japan did poorly on both counts. Not only did it squeeze the money supply, it also did not pressure banks to dispose of non-performing loans. Another mistake was that the speed of adjustment was too slow. In Japan it took 13 years before the CEO of a damaged bank was fired. In this regard, the U.S. is doing much better.