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What The Fed Fears: People Who Can’t Remember Rising Prices

Many Japanese consumers grew up with low prices and now punish retailers when they try to raise them. What The Fed Fears: People Who Can’t Remember Rising Prices

Figuring out the public’s expectations of future inflation—and trying to influence them—is core to any central banker’s work. Yet Japan shows how hard that becomes when many people barely grasp the concept of steadily rising prices.

“Those who were born in the 1980s and 1990s almost have no experience of inflation. So even if they were told inflation was coming, they didn’t believe it,” said Tsutomu Watanabe, a Tokyo University professor and former central banker.

A 20-year-old in Japan today has experienced average inflation of 0.1% over his or her lifetime. No wonder Bank of Japan Gov. Haruhiko Kuroda’s repeated vows to reach 2% inflation haven’t worked out.

An extended period of nearly flat prices is the essence of the “Japanification” specter that worries the U.S. and Europe.

The Federal Reserve, like the Bank of Japan, seeks 2% inflation because it sees that level as consistent with a healthy economy. U.S. inflation has held close to but below the target for years, and Fed officials are reviewing their inflation targeting framework to avoid succumbing to the low-inflation trap that has bedeviled Japan. Among the options under consideration are approaches that would more explicitly allow or even encourage inflation above 2% in hopes of lifting inflation expectations.

The problem, central bankers believe, is that low-inflation expectations can be self-fulfilling if they cause consumers to balk at higher prices and businesses to refrain from raising prices and wages.

“Inflation that runs persistently below our objective can lead to an unhealthy dynamic in which longer-term inflation expectations drift down, pulling actual inflation even lower,” Fed Chairman Jerome Powell said at a Dec. 11 news conference.

Natsumi Ozaki, a university student who works part time at Tokyo Disney Resort, said she has forgone purchases after noticing price increases on souvenirs.

“I am often surprised how such a small thing can cost so much,” she said. “I sometimes have to give up on buying because prices are higher than I remember.”

In recent years, Mr. Kuroda has pointed to research suggesting inflation expectations are adaptive: People predict future prices based on what they have seen in recent years. In practice, that means Japanese consumers have accustomed themselves to seeing everyday goods at low prices and punish any retailer that tries to raise them.

Rina Sato, a 22-year-old college student, said she avoided treating herself to a soft drink recently because supermarkets in her neighborhood held off from discounting. “Because I know the price can be lower, I don’t want to buy at the regular price,” she said. “If I wait for a while, prices will probably come down.”

Hideo Hayakawa, a former executive director at the Bank of Japan, recalled a backlash from younger economists when he was briefing them soon after the central bank started buying large amounts of bonds from commercial banks in an effort to spur inflation. Consumers seeing cash flood into the banking system from the bond sales would surely prepare for higher inflation, he explained. The younger economists, he said, thought it would be hard to implant such expectations in people unaccustomed to rising prices, and they were right.

Even consumers old enough to remember inflation might not share a central banker’s 21st century perspective on it. To Messrs. Powell and Kuroda, achieving modest, steady inflation of around 2% keeps a nation away from a negative spiral of falling prices, declining wages and weak demand. But to the average person, rising prices sound like a bad deal.

Fed officials at their December meeting “generally agreed that they need to communicate more clearly to the public their rationale for, and commitment to, achieving 2% inflation on a sustained basis,” according to minutes of the discussion.

Another problem for many central banks around the world is they cut interest rates to near or below zero after the financial crisis to boost growth and inflation, with mixed success. Today, both inflation and interest rates remain very low, leaving the officials little room to lower interest rates in the next recession.

Former Treasury Secretary Lawrence Summers said in a recent interview that central banks have exhausted their ammunition. “Once you get into a near-zero interest-rate regime, it’s kind of a black hole,” he said.

Mr. Kuroda said escape is possible—it just takes a long time. He has said gradual increases in wages and prices, even if they are mild, will change perceptions about future prices.

Rentaro Nomura, a 22-year-old college student, has won two pay increases in the past four years in his part-time job at a wedding hall, where he now earns nearly $13 an hour. He said he is looking forward to starting a full-time job after graduation and expects his salary to go up.

But he also said he wants to save his income because he’s worried about life after retirement, suggesting wage gains might not feed the kind of stronger demand that lifts prices.

Tokyo University’s Prof. Watanabe isn’t as confident as Mr. Kuroda. “The view of prices among those in their 20s and 30s will probably never change for the rest of their lives,” he said.


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