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Deflation: The World’s Biggest Economic Problem

By: Shayan Mukherjee

Caption: The struggle of the Japanese economy to combat an aging population and its increasingly conservative mindset is a telling sign: deflation could spell future economic devastation all around the world.

Along with being the birthplace of anime and for its natural beauty, Japan is also known for the healthy lifestyle lead by its population. According to the website BBC Goodfood, the traditional Japanese diet is one of the healthiest in the world due to its high content of largely fresh and unprocessed ingredients that are rich in nutritional value. Additionally, a study from Mindfulness Box revealed that an estimated 3.3 million people in Japan practice meditation and/or mindfulness exercises in 2023. This has caused the population to have one of the highest average life expectancies in the world: at a whopping 84.95 years old, Japan sits 3rd, only behind Hong Kong and Macau (Worldometer). As people live longer, the population has started to lean towards an older demographic: the median age of the Japanese population is increasing at a rate of 5.68% and the percentage of the population that is above the age of 60 is at an alarming 29.1%.

Population changes are a key factor affecting consumption patterns, and, by extension, aggregate demand (i.e., the total money being spent on purchasing goods and services) in an economy. As the population grows older, people purchase less: elderly people have fewer needs and wants than the youth, meaning that the average household expenditure is falling. Furthermore, as more individuals are now above the retired age, the size of the labour force is also decreasing, meaning fewer people in Japan are earning incomes. This has contributed to a sustained fall in the total demand within the Japanese economy in the last few years.

However, Japanese firms still need to survive and make a profit. In an attempt to attract more customers to the market (and therefore increase their revenue), firms across all industries have lowered prices. This fall in the average price level is what we call deflation.

But, I hear you ask, shouldn’t this reduction in prices have solved the problem? Wouldn’t consumers be encouraged to go to the shops and buy items again at lower prices? Why do prices continue to fall?

Unfortunately, the problem lies in the attitude of the Japanese population. Having witnessed these reductions in prices, they have begun to predict that prices will continue to fall in the future. Why should they go to the shops to buy goods now if they know that, in all likelihood, prices will fall even lower next month? Ironically, while this makes economic sense, it is these future price expectations that are causing the fall in price levels to be sustained. Individuals do not consume because they know the prices are going to fall and firms lower the prices because individuals do not consume. For the last 25 years, Japan has remained trapped in this vicious economic cycle.

The fact that reversing deflation will require a change in the inherent, conservative mindset of the people makes it an incredibly difficult problem to solve. The Bank of Japan, the nation’s central bank, have tried to step in by reducing interest rates, but the country remains entrenched in economic stagnation. As I write this, Japanese economists are still trying to find a solution.

And, as medicine improves and populations around the world become older, we might soon join them in their struggle.

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