[Financial Planning for the 100-Year Life] Does the Rise in Japanese Stock Prices Signal an End to Deflation?

Nikkei 225 Surges 18.4% This Year, Outpacing Developed Markets
GDP Deflator and Nominal GDP on the Rise
Japan Breaking Away from Being the Only Country Where Nominal GDP Lags Behind Real GDP

This year, Japanese stock prices have risen much faster than major global stock indices, and along with this, signs are emerging that the Japanese economy is escaping deflation. According to Morgan Stanley Capital International (MSCI), the global stock index rose 6.8% (7.6% for developed countries) from the beginning of this year to May. However, Japan's representative stock index, the Nikkei 225, surged by 18.4%. Looking at the medium to long term, the stock index, which was 8,110 in March 2009, has recently surpassed the 30,000 mark.

Analyzing quarterly data from 1994 to 2022, the Nikkei 225 was found to lead nominal Gross Domestic Product (GDP) by one quarter (correlation coefficient 0.73). Just as stock prices have risen, nominal GDP has also recently increased.

Nominal GDP consists of real GDP and prices. Real GDP is increasing moderately. In particular, Japan's real GDP growth rate in the first quarter of this year, calculated on an annualized basis, was 1.3%, higher than that of the United States (1.3%), the Eurozone (0.3%), and even South Korea, which also recorded 1.3%. Additionally, the GDP deflator, which represents the overall price level of a country, is also rising.

Generally, when the GDP deflator continuously declines, it is said that the country's economy has fallen into deflation. The GDP deflator, which was 100 in the first quarter of 1994, dropped to 84.5 by the fourth quarter of 2013. This means that the Japanese economy was in deflation for nearly 20 years. However, since then, the GDP deflator has been rising moderately, reaching 90.8 in the first quarter of this year. Prices are increasing.

Consumer prices in January this year also rose 4.3% compared to the same month last year (3.4% in April), marking the highest level in 41 years since December 1981. Considering the rising GDP deflator and increasing nominal GDP, it can be said that the Japanese economy is escaping deflation.

The turning point for the Japanese economy to break free from deflation was "Abenomics." Shinzo Abe, who took office as Japan's Prime Minister in December 2012, implemented various economic policies to free the Japanese economy from long-term deflation. One of these was maintaining negative interest rates and increasing the money supply indefinitely to achieve a 2-3% inflation target. In fact, the monetary base surged 3.2 times between 2012 and 2016. Since then, the supply of Japan's monetary base has continued to expand.

The decline in the working-age population also appears to contribute to rising prices. Following the total population, the population aged 15 and over began to decline from 2021, and additional economic activities by women and the elderly, who had supported labor supply, are shrinking. As the relatively productive population decreases and the consumer population increases, this acts as a factor driving price increases.

As these factors interact, household expected inflation rates have recently risen, and actual wage growth rates have also increased. The total wage increase rate, including regular spring raises, was 3.7%, the highest level in 40 years since 3.9% was recorded in 1993.

Japan was the only country where nominal GDP was lower than real GDP due to a declining GDP deflator. However, recently, with rising prices, the normalization process is progressing, albeit gradually. The stock market has been reflecting this prematurely. As of the first quarter of this year, the Nikkei 225 is overvalued by about 13% relative to nominal GDP. Therefore, some stock price correction seems inevitable. However, in the long term, there is a high possibility that the GDP deflator will shift to an upward trend and nominal GDP will continue to increase. This is why attention should be paid not only to the U.S. but also to the Japanese stock market.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University