Inflation and Deflation in East Asia

In economics, inflation is one of the most important concepts that affects almost all other notions in calculating their real values. In spite of its importance, the calculation of inflation is widely misunderstood. It is often considered as a straightforward formula, like those applied for population statistics or foreign exchange reserves. But, the fact is that statistical experts do make judgements with regard to which techniques they adopt when it comes to item replacement and quality adjustment. According to this judgement, the values of inflation statistics become different. Moreover, the judgements are co-ordinated at national level in order to avoid arbitral decisions, but not at international level. As a result, inflation statistics are calculated by different quality-adjustment techniques in countries. Technological innovation decreases the production costs of goods and services as well as their prices. In this sense, inflation cannot escape the influence of technical innovation. In this chapter, how technological innovation influences inflation statistics in different ways in East Asian countries is investigated.

During the period 2012–2017, Korea’s inflation slipped to a very low level, notwithstanding the accommodative monetary policy. Focusing on the transmission channel of lower interest rates on house rents, this study argues that the official consumer price index (CPI) in Korea understated the true inflation rate because Korea has a unique rental system, known as the chonsei contract. Under this contract, the tenant pays the landlord a large, lump-sum, upfront deposit without a periodic rent payment, and the landlord derives his returns from the interest accrued on the deposit. Thus, a cut in interest rates induces the landlord to offset the loss on his returns by charging the tenant a larger upfront deposit, which should have raised the CPI inflation. However, this effect was not properly captured owing to the growing prevalence of a hybrid chonsei contract, under which the tenant makes a periodic monthly payment as well as the upfront deposit. Thus, a low interest rate converts the upfront deposit paid under the hybrid chonsei into lower interest flows, significantly under-estimating the rent and CPI. An examination of the official CPI figures alone will in all likelihood misguide monetary policy.

This chapter discusses the deleterious effects of inflation on the financial statements of firms, even in countries reporting low inflation rates. The first objective towards achieving this aim is presenting and describing the rationale underlying the Brazilian model for recognising inflation in financial statements, based upon identifying the gains and losses arising from monetary assets and liabilities. Brazil has experienced inflation for more than five decades; the Brazilian model is, therefore, considered the main mechanism for recognising the impact of inflationary effects in financial statements. Second, using the multiple case study methodology, this chapter aims to apply this Brazilian model to a set of firms located in a country with a low inflation rate, such as South Korea (14% inflation in the past decade). The results are consistent with previous studies that found that inflation can result in significant misstatements in financial statements even in an environment with low inflation rates. For instance, at an inflation rate of 2.3%, the Korean Air Lines Co. reported the difference between nominal earnings and real earnings as 192%. This study contributes not only to academic literature, but also to the preparers of financial information, investors, analysts, and accounting regulatory bodies by drawing their attention to the fact that even currently disclosed nominal financial statements may contain material misstatements.

Inflation dynamics in Singapore have primarily been shaped by foreign factors, including global inflationary pressures and external macroeconomic shocks. More recently, the normalisation phase of the Covid-19 pandemic crisis has led to domestic price pressures from pent-up demand and supply chain disruptions. Meanwhile, the war in Ukraine has resulted in a hike in the global prices of food, energy, and industrial commodities. Using inflation forecasts from the MAS Survey of Professional Forecasters as our measure of inflation expectations, we show that short-term inflation expectations started shifting up particularly in 2022. Moreover, greater disagreement amongst survey respondents in the 2022 quarter one survey suggests individual short-term inflation expectations may also be slipping. The Monetary Authority of Singapore (MAS) has promptly responded to the elevated price pressures by repeatedly tightening monetary policy. Such forceful policy responses reveal the central bank’s resolve to maintain price stability, which will help to ensure that inflation expectations in Singapore remain anchored.

Like many small open economies, Taiwan’s domestic prices are susceptible to international price volatility (e.g., crude oil prices) and seasonal fluctuations. Considering these transitory factors, the Central Bank of the Republic of China (Taiwan) has long-defined price stability, in accordance with the government’s macroeconomic targets of keeping inflation below 2%, as an annual growth rate of the consumer price index (CPI) in the range of 0–2% over the medium term. In the past 20 years, inflation has remained low and stable in Taiwan, with the CPI growing at an average annual rate of 1%. Because of a low and stable inflation environment, inflation expectations are well-anchored, which, in turn, helps to keep domestic inflation under control. However, the recent surge in global price levels due to the Covid-19 pandemic, supply chain bottlenecks, and the war in Ukraine, has brought inflation back to the forefront of monetary policy. Many countries have identified the elevation in price pressures as a potential threat to their economies, and Taiwan is no exception.

This chapter discusses inflation in Japan. It explains why inflation has not built up despite the extreme expansionary monetary policy by the Bank of Japan. Even amidst the recent global increase in inflation, the inflationary pressure has remained comparatively low in Japan. We argue that Japan’s low inflation is caused by two main factors: a declining and ageing population, and a labour market environment that constrains the bargaining position of employees. A new school of thought called Neo-Fisherism adds an interesting argument to the debate on inflation. Pointing theoretical and empirical research, it suggests that a higher inflation rate can be achieved by raising nominal interest rates. The idea is controversial and has yet to be tested by central banks. We also agree that it would be too risky for Japan to apply Neo-Fisherism, not least because the welfare gains from higher inflation remain dubious.

The term “inflation” is never used by the primary law of the European Union when unfolding tasks, objectives, and instruments of monetary policy. Only by re-defining its primary objective “maintain price stability” could the Eurosystem construe an “inflation target” as its legal goal in this way, eschewing to fall back on Article 127(5) TFEU, which would also demonstrate this aberration when interpreted correctly. To sum up, inflation targeting, as a task, competence, or objective of the Eurosystem, is—legally—highly questionable according to the common standards of interpretation, if it would imply striving for an increase of price levels greater than zero. It might, however, be safe to predict that the Court of Justice of the European Union would disagree.

In the years after the Great Financial Crisis (GFC) (2007–2008), the central banks of the advanced economies adopted the so-called unconventional monetary policies (UMPs). The Bank of Japan (BoJ), like the other central banks, gradually changed its policy instruments from conventional ones, such as open market operations, to UMPs. UMPs raise concerns about legality, i.e., whether they exceed the legal authority granted to the central bank, and concerns about legitimacy, i.e., why a central bank with a “democratic deficit” could adopt such policies. This chapter will mainly focus on a legal analysis of the BoJ’s UMPs. It begins with an overview of the BoJ’s current monetary policy framework, which consists of inflation targeting, an extensive and broad-scale asset purchase programme, and yield curve control, then the Bank of Japan Act of 1997 (1997 Act) will be described and analysed. There are several legal or constitutional issues to consider in relation to the BoJ’s independence. The 1997 Act shares the common features with the modern central bank law that has been accepted worldwide since the 1990s. The 1997 Act provides price stability as the objective of the BoJ’s monetary policy, guarantees the BoJ’s independence (autonomy) more strongly than before, and introduces mechanisms to ensure both accountability and transparency. But, the 1997 Act also gives the BoJ a variety of policy objectives other than monetary policy, adjusts the degree of independence within that scope, and pays attention to co-ordination with the government. Against these backgrounds, the compliance of the BoJ’s UMPs with the 1997 Act is examined. The BoJ’s UMPs—although admittedly in a grey zone—cannot yet be assessed as being illegal. The BoJ has repeatedly stated that the UMPs are in compliance with the 1997 Act. Both the general public and the Diet also accept this explanation, at least on the surface. It is understood that the BoJ’s monetary policy has been found to be compliant with the 1997 Act through this accountability mechanism. However, even if this is the case, this does not mean that legitimacy problems do not arise. The UMPs adopted have significant fiscal and economic consequences. Such a policy in support of fiscal and economic policy may, in some cases, lead to a situation in which the central bank is subordinated to the government.