Deflation can create drag on Japan economy

TOKYO (AP) — Japan’s government highlighted the danger of deflation for the first time in three years Friday, warning that falling prices and a further worsening of the labor market could drag on the weak recovery.

Meanwhile, the country’s central bank, which kept its key interest rate on hold at 0.1 percent, took a slightly more upbeat view in its monthly assessment of the economy because of an improvement in exports and private consumption.

The mixed outlook comes at a crucial juncture for the world’s second-largest economy. It expanded at a stronger-than-expected rate in the third quarter amid rising factory output but the job market remains tough and many companies have reported quarterly losses.

The Cabinet’s statement about deflation, coming in its monthly economic report, is hardly a surprise as Japan’s consumer price index has been declining for months now.

But it shows that Japan’s leaders are clearly worried about the trend. Falling prices, which plagued Japan during its “Lost Decade” in the 1990s, may sound like a good thing, but deflation can hamper economic growth by depressing company profits, lead to wage cuts and cause consumers to postpone purchases. It can also increase debt burdens.

“If consumers expect prices to fall further, they will stop spending and try to save. That’s the biggest worry,” said Hiromichi Shirakawa, chief Japan economist at Credit Suisse. “That would invite further deflationary pressure. That would have a knock-on effect on companies, on the government and everywhere.”

It was the first time since August 2006 that the Cabinet report identified deflation as a problem.

Overall, the report said that while the economy has been “picking up, it is short of autonomous factors and remains in a difficult situation such as a high unemployment rate.” The jobless rate has retreated from a record 5.7 percent in July to 5.3 percent in September — still high by Japanese standards.