Japanese consumption-tax rate increase

Today, I would like to a little bit about what some next steps the Japan had taken for its famous Abenomics. Today, Japanese government increased the sales-tax from 5% to 8%. There is no surprise here since this was part of Abenomics plan announcement well back in 2012. But, I want to do a half-time check on how Japan is doing with its plan and see whether it really had a significant effects in many dimensions of economics.

It is hard to talk about Japanese economy without what we call the lost decade–which had continued to reach two decades soon. I already have a blog post on the lost decade, so please go here for more details. Anyhow, the short version is that after 1990’s real estate bubble, Japan has seen very low inflation rates or even deflation–staggering growth and sometimes contracting up until recent years.

The biggest problem with low inflation is that the economy becomes highly vulnerable to any supply shocks. The central bank also loses control over its monetary policy tool. Even with the lowest interest rate of 0%, negative inflation will bring real interest rate to positive side, resulting in net capital inflow and loss in net export. Just a glimpse on the graph below shows very high volatility in inflation.

Screen Shot 2014-03-31 at 6.07.00 PM (Source)

To make up for the big loss in exports and domestic private investments, the government had to spend a lot–and I mean A LOT (see graph below).

Screen Shot 2014-03-31 at 6.11.31 PM

 

The debt-to-gdp ratio was at about 67% and now the owe more than twice of their income.

To be fair, this was part of Abenomics’ goal. In order to raise consumption and investment momentum it had lost two decades ago, Japanese government spent enormous amount in fiscal spending . Japan also used very loose monetary policy, weakened the yen and made it stay there to restore some balance in the trades.

I want to give Abenomics some credit in restoring its economy. Although it went down 9% this year thus far, the Nikkei rose 57% last year. Also, it is on its way to reach the inflation target of 2% (now at 1.3%). On the other side, I think Japan is playing it very close to the line with continuing rise of the debt. Yes, they decided to raise the consumption sales-tax to 8%, but the condition for continued high confidence level of Japan is I think still very unpredictable.

Some pessimists like Gordon Chang is appalled by Japan’s approach and think Japan is undoubtedly going to default, causing massive financial crisis around the world. Other countries that has trading competition with Japan, countries like EU, South Korea, etc. complain that it is very unjust for them to play the beggar thy neighbor measures.

I personally think that what Abe’s government did has no moral culpability. Ignoring the fact that Japan is still number 3 in terms of total nominal GDP, I think they used their last bullet in the gun to comeback to their heydays growth level. They ran out of fiscal instruments for a very high debt level. Monetary policy had been inoperative for many years and now even more so perhaps. Abenomics took the eat-a-lot-now-and-fast-later approach. As we are coming into the fasting part, Japanese should hope that their momentum while they were eating will not lose out.