Deflation in Japan may lead to a deeper recession

The economic woes for Japan, world's second largest economy after US, had deepened with the GDP for the last quarter of 2008 falling sharply, down by 3.3% from previous quarter and 12.7% annualized. This is the sharpest decline since 1974 oil crisis. This was the third consecutive quarterly decline in GDP. Japan has high dependence on exports and because of ongoing financial crisis in the US and European countries exports have fallen considerably.

Japan has been facing tough economic situation since more than a decade. It had seen consistent deflationary periods from 1999 to 2006. However GDP growth had picked up since 2003 and stood at a decent 2% in 2007. The year 2008 saw a fall in growth rate to 0.3% and in 2009 it is expected to be -2% (JCR projections).

The fall in global commodity prices has put downward pressure on inflation. According to the official data, the consumer price index for Japan in December 2008 was 101.3 (base year 2005=100), down 0.4% from the previous month, and up 0.4% year-on-year. A fall in prices will add on to the slowdown of economy. A period of deflation generally results in lower savings and investments. It may also lead to deflationary spiral in which fall in prices lead to lower production activities and hence lower wages leading to decreased purchasing power and lower demand. In history this kind of viscious deflationary spiral occured during the Great Depression.