Bank of Japan implements modest credit facility as deflation deepens

Deflation -- a protracted, systematic decline in prices and wages -- occurs in pronounced recessions and other conditions in which demand is weak. Robbing companies of the ability to increase revenue, it handicaps the economy's ability to grow. If it takes hold, deflation can lead to the dreaded 'deflationary spiral,' in which price cuts lead to lower corporate revenue, prompting more lay-offs, leading to further consumer spending declines, prompting more price cuts, and so on.

Inflation hawks -- those who argue that central bank quantitative easing and government fiscal stimulus spending will lead to an increase in inflation -- have cautioned policy makers in the U.S., E.U., and Japan against extensions of credit facilities and/or additional fiscal stimulus packages on price stability grounds. So far, the concern has been baseless: consumer prices have dropped for eight straight months in Japan, Bloomberg News reported. Meanwhile, in the U.S., consumer prices have dropped 0.2% in the past 12 months.

Monetary/Economic Analysis: The markets interpreted the Bank of Japan's action as inadequate: perhaps if the facility was triple the size -- $300 billion -- it would help stabilize prices. More broadly, deflation in Japan threatens to remove one growth engine from the global economy -- hence, that deflation must be eliminated. Moreover, it provides more evidence that the inflation risk is nowhere near what's being projected from the inflation hawks, who nevertheless receive a great deal of attention (unwarranted) from the 24-hour cable news networks, MSNBC, CNN, and Fox News. For inflation to surge, the U.S. would have to add about 3-4 million jobs quickly: that's not going to happen any time soon. In Japan, there would have to be a sustained increase in the birth rate (not likely), and a sudden shift by consumers to spend more. Bottom Line: Deflation, not inflation, remains the greater risk for the U.S., Japan, and the E.U.