By: Dr. Mike Campbell

Perpetually falling prices sounds like a consumer’s dream, but in economic terms, deflation is a bad thing. If you know that a big ticket item will be cheaper in a few months than it is today, you are likely to delay your purchase. The combined effect of many people doing this is to reduce demand within the economy which stifles growth since for most countries, internal demand accounts for the lion’s share of consumption of goods and services.

Japan has been free of deflation for the past four months, but recent figures show that deflation has returned to the economy. The core consumer price index (which excludes fresh fruit) showed a decline of 0.1% in October. The Japanese government has passed a budget of $155 billion which is aimed at reconstruction activities following March’s earthquake and tsunami. Reconstruction activities are expected to boost both domestic demand and economic growth, but the effects will take several months to feed through.

To add to the problems facing Japan, October also saw the first contraction in exports for three months. The year-on-year data showed a 3.7% decline, according to the Ministry of Finance. Japan is suffering from a strong Yen which makes her exports more expensive (and therefore less competitive) in importing markets. A strong Yen does mean that raw material prices are reduced (since they are priced in US Dollars) and weak global demand has dropped the price of crude oil meaning that energy costs are also lower.

The Bank of Japan acted to weaken the Yen at the end of last month, but although the Yen remains well above the record high levels against the Dollar, more than half of the depreciation has been lost due to concerns over the sovereign debt crisis in Europe and sluggish growth in the US. Japan and the USA both have debt problems which dwarf those in Europe, but for the moment, markets do not seem to have taken this on-board.