One of the less palatable consequences of deflation is of course the reality that what goes up can also come down, that systems where wages and pensions are effectively indexed to prices mean, that when prices come down, wages and pensions come down too. Of course, what is less well studied is how such reductions will be received and understood by those on the receiving end. Among other important consequences of today's decision to reduce indexed pensions in Japan must be the implictation that, in the eyes of many with responsibility for decision making in Japan, deflation is now settling in for the long haul.
Japan's retired population will for the first time suffer the consequences of deflation when the government cuts the monthly pension by 0.9 per cent in line with the falling consumer price index. Until now, retired people in Japan have been largely shielded from the effects of deflation, since a political decision to decouple their benefits from the CPI when prices began to fall three years ago. Most retired people, few of whom are exposed directly to the stock market, have benefited from deflation, which has boosted their real spending power. The government's decision to make pensioners share some of the burden amid a stagnating economy and sharply worsening demographics is highly symbolic. It could well presage aggressive moves to renege substantially on promised pension benefits, analysts said.
On Friday, the cabinet re-established the link between prices and pensions, which were first indexed in 1973. As a result, the state pension for an average head of household will be cut by �2,140 ($18, �17, �11) to �235,980 a month. The move could change the psychology of deflation, Jeffrey Young, senior economist at Nikko Salomon Smith Barney, said. "The relinking of benefit back to the CPI may start to convince seniors that deflation is not the greatest thing in the world," he said. "This is the first time that, in a very direct and visible fashion, they can see: 'Oh, falling prices means my income is going to be cut as well'." Explaining the change of policy, a government official said it was necessary to prevent the deterioration of the social security system's finances. The system fell into deficit for the first time last year, a situation that will get significantly worse. The labour force is shrinking by 0.6 per cent each year as baby boomers retire, reducing the size of total premiums and raising the amount that must be paid out in pensions.
Source: Financial Times