Tag Archives: Abenomics

(Revised) Can QE* Be an Effective Long Term Policy? Yes, and Here’s How.

The Fed’s decision to implement quantitative easing and other unconventional monetary policy in December 2008 sparked a blaze of heated discussion amongst economists that has been burning to this day. The questions of if and how these new measures affect economic growth have become the focus of countless blog posts and editorials, and have become an integral part of many university Econ courses. The beginning of QE tapering in December 2013 added even more fuel to the fire, but it also gave many traditional economists a sense of relief. It finally looked like there was an end in sight to these unfamiliar and controversial policies. To the dismay of these traditionalists, however, recent research by the Brookings Institution (paper #1 and paper #2) suggests that there are significant benefits of pursuing unconventional monetary policy in the long term. A recent Economist article, “Staying Unconventional,” emphasizes some of the most important results of this research and raises a provocative question: Can QE and forward guidance, or some alternate forms of these policies, be combined to create an effective long term policy?

Based on my reading of the research papers that the article cites, I am inclined to say yes. It may not be the QE policy currently being rolled back, but I can see an alternate form of such a policy (hence the * in the title) being effective in the long term. Not only does unconventional monetary policy not cause riskier financial behavior, but it also provides a substantial boost to economic growth. In this blog post, my goal is to defend the bolded argument by highlighting some of the key findings of the research papers I mentioned earlier.

1.    Unconventional Monetary Policy Does NOT Cause Financial Instability

The argument commonly used to refute long-term implementation of QE is that it encourages individuals and financial institutions to pursue riskier investments, thereby reducing financial stability. The prediction is that long periods of low interest rates incentivize investors to ‘reach for yield’ and take on more credit risk, duration risk, and/or leverage. The research by Gabriel Chodorow-Reich of Harvard University confirms this prediction but emphasizes that the story is not so cut and dry. Although the Fed’s low interest rate policy has caused financial institutions to take on some riskier investments, it has also boosted the value of these institutions’ portfolios, making them less risky and strengthening the stability of the U.S. economy. Most importantly, Chodorow-Reich’s analysis shows that the stabilizing effect of QE has been stronger than the destabilizing effect caused by ‘reaching for yield.’

Chodrow-Reich determined the magnitude of each effect by evaluating the effect of the Fed’s policies on four categories of financial institutions: life insurers, commercial banks, money market funds, and defined benefit pension funds. Together, these institutions manage $24 trillion in assets. The effects are nicely summarized in the graphic provided in the abstract of the paper:

unconventional MP_1

As Chodrow-Reich states, “In the present environment, there does not seem to be a trade-off between expansionary [monetary] policy and the health or stability of the financial institutions studied.”

If the biggest argument against long-term use of QE (investors reaching for yield) is nullified, perhaps the Fed should think twice about continuing to taper. There is, however, the problem of surprising the market with such a change in policy. A possible solution to this is to continue the taper, but then start buying a constant level of bonds again after the taper is complete. If the Fed warns the public of such a long term policy change in advance, it could dampen the volatility the move would create in the markets.

2. Unconventional Monetary Policy Boosts Immediate Economic Growth and May Have Substantial Long-Term Growth Benefits As Well

The research conducted by Joshua K. Hausman (University of Michigan) and Johannes F. Wieland (University of California, San Diego) examines the success Abenomics has had in boosting Japanese GDP and gives insight into how such unconventional monetary policy can sustain amplified GDP growth in the long term.

Named after Japanese Prime Minister Shinzo Abe, ‘Abenomics’ is the name used to refer to Japan’s current three-pronged economic stimulus policy, which consists of a combination of monetary policy expansion, fiscal stimulus, and structural reform. It is the only real and current example of long-term unconventional monetary policy, and is thus viewed by economists as an important test of its validity.

So far, Abenomics has stood up to the challenge. The Japanese stock market has risen, the exchange rate has depreciated, and Japan’s GDP has jumped by up to 1.7%. Hausman and Weiland claim that one percent of this GDP growth has been directly caused by the monetary policy shift. Furthermore, Abenomics’ effect on the Japanese money supply has been much more effective than that of previous QE policies. The below graphic from the Economist article provides a nice summary of the effects of Abenomics:

unconventional MP_2

Hausman and Weiland attribute the superior effectiveness of Abenomics to the change in inflation expectations it has caused. Japan has set a new 2 percent inflation target and because Abenomics was announced to the public as a permanent change in policy rather than a temporary measure to boost GDP, inflation expectations increased for both the short and long terms. Both short and long-term borrowing appeared cheaper as a result. This, in turn, caused borrowing to increase across the board, stimulating increased consumer spending.

One should not go all-in on Abenomics quite yet, though. Both the article and research paper emphasize that Abenomics is still in its initial stages and has yet to prove itself as an effective catalyst for long term growth. When discussing the long-run outlook of Abenomics, Haussman and Weiland assert:

The research shows that the Bank of Japan is achieving its intermediate objective of higher expected inflation, but that the inflation target itself ‘remains imperfectly credible,’ with long-run inflation expectations below 1.5 percent.  Thus the modest estimates of Abenomics’ effects reflect in part that the Bank of Japan has not yet fully convinced the public that inflation will be two percent.

If the Bank of Japan could somehow more strongly convince the public of a future two percent inflation rate (perhaps through a public announcement reinforcing its intention to pursue the policies of Abenomics), the effects could be substantial. Hausman and Weiland estimate that “the output effects of Abenomics could as much double if inflation expectations rose to the 2 percent level.

In summary, based on the results presented by Gabriel Chodorow-Reich about the positive effects of QE on financial stability, and Hausman and Weiland’s estimates of past and future Japanese output growth as a result of Abenomics, I am convinced that unconventional monetary policy can be used effectively in the long term. If the Fed can convince the public that inflation will be steady at two percent and interest rates will remain low, whilst continuing to purchase assets and pursuing fiscal stimulus, it can achieve both strong economic growth and increased financial stability.

(Revised) Japan’s increase in sales tax – right decision?

In my previous blog post Japanese economic growth – now time to stimulate export, I wrote about how Abenomics has not been successfully increasing the Japanese export. Furthermore, I was concerned about Japanese economic recovery, as Japan’s recovery is mainly driven from increase in domestic consumption. In April 1st 2014, Japan’s domestic sales tax rose from 5% to 8%, as announced at the beginning of Abenomics plan. Japan’s Prime minister Abe Shinzo’s aggressive monetary policy did help Japan to escape from its continuing deflation, yet I am worried if this rise in sales tax will go against Abe’s monetary policy.

According to the Wall Street Journal article Japan’s Sales-Tax Boost Will Test Abenomics, Japanese government’s decision to increase sales tax worries many economists. As it can be seen from the graph below, Japan have once increased its sales tax in 1997 from 3% to 5%. The result was disappointing, as Japan suffered from a decrease in consumption and continuing deflation and recession for more than 18 months. Bank of Japan forecasts that Japan’s Consumer Price Index will be at its steady rise of 1.3% for remainder of 2014 and then reach its target rate of 2.0% by 2015, while private economists forecast that Japan might go back to its long-time deflation, with rate lower than 1%.

EI-CG569_OUTLOO_G_20140330160004

The article from Reuters Abe bets he can break Japan sales tax jinx with April 1 rise points out that the main reason for this increase in sales tax is to curb Japan’s massive public debt. From the FRED graph below, it is obvious that Japan’s public debt is increasing drastically. Jesper Kroll, head of equities research at JP Morgan insists that “2014 is not 1997”, saying the probability of success (in rising sales tax) is better than ever. He cited a tight labor market, increased household and small-business burrowing and a $53.44 billion extra budget enacted in last December will cushion the impact of the sales tax rise.

japandebt

However, I am still concerned about this tax rise. As I have already mentioned in my previous blog post Japanese economic growth – now time to stimulate export, Japan’s economic recovery in 2013 was driven from domestic consumption (not international trade) despite aggressive Abenomics. While Yen is still strong, Japan’s export is unlikely to boost in a huge amount in 2014 as well. Therefore, if Japan’s domestic consumption is reduced due to an increase in sales tax, then it is probable that Japan will be unable to maintain the fast rate of economic recovery from 2013. Therefore, I think it is extremely important for Japanese government to keep an eye on Japanese economy (especially its domestic consumption and CPI index) and execute necessary monetary and fiscal policies if increase in sales tax goes to an opposite direction to where Abenomics is heading.

Can QE* Be an Effective Long Term Policy? Yes, and Here’s How (Part 2)

The research conducted by Joshua K. Hausman (University of Michigan) and Johannes F. Wieland (University of California, San Diego) examines the success Abenomics has had in boosting Japanese GDP and gives insight into how such unconventional monetary policy can sustain amplified GDP growth in the long term.

Named after Japanese Prime Minister Shinzo Abe, ‘Abenomics’ is the name used to refer to Japan’s current three-pronged economic stimulus policy, which consists of a combination of monetary policy expansion, fiscal stimulus, and structural reform. It is the only real and current example of long-term unconventional monetary policy, and is thus viewed by economists as an important test of the policy’s validity.

So far, Abenomics has stood up to the challenge. The Japanese stock market has risen, the exchange rate has depreciated, and Japan’s GDP has jumped by up to 1.7%. Hausman and Weiland claim that one percent of this GDP growth has been directly caused by the monetary policy shift. Furthermore, Abenomics’ effect on the Japanese money supply has been much more effective than that of previous QE policies. The below graphic from the Economist article provides a nice summary of the effects of Abenomics:

unconventional MP_2

Hausman and Weiland attribute the superior effectiveness of Abenomics to the change in inflation expectations it has caused. Japan has set a new 2 percent inflation target and because Abenomics was announced to the public as a permanent change in policy rather than a temporary measure to boost GDP, inflation expectations increased for both the short and long terms. Both short and long-term borrowing appeared cheaper as a result. This, in turn, caused borrowing to increase across the board, stimulating increased consumer spending.

One should not go all-in on Abenomics quite yet, though. Both the article and research paper emphasize that Abenomics is still in its initial stages and has yet to prove itself as an effective catalyst for long term growth. When discussing the long-run outlook of Abenomics, Haussman and Weiland assert:

The research shows that the Bank of Japan is achieving its intermediate objective of higher expected inflation, but that the inflation target itself ‘remains imperfectly credible,’ with long-run inflation expectations below 1.5 percent.  Thus the modest estimates of Abenomics’ effects reflect in part that the Bank of Japan has not yet fully convinced the public that inflation will be two percent.

If the Bank of Japan could somehow more strongly convince the public of a future two percent inflation rate (perhaps through a public announcement reinforcing its intention to pursue the policies of Abenomics), the effects could be substantial. Hausman and Weiland estimate that “the output effects of Abenomics could as much double if inflation expectations rose to the 2 percent level.

In summary, based on the results presented by Gabriel Chodorow-Reich about the positive effects of QE on financial stability, and Hausman and Weiland’s estimates of past and future Japanese output growth as a result of Abenomics, I am convinced that unconventional monetary policy can be used effectively in the long term. If the Fed can convince the public that inflation will be steady at two percent and interest rates will remain low, whilst continuing to purchase assets and pursuing fiscal stimulus, it can achieve both strong economic growth and increased financial stability.

Sales tax increase in Japan(Revised)

The Wall Street Journal introduced an interesting story of Hideo Noda, an ordinary Japanese office worker, who recently went shopping spree. The reason why he was hurried buying expensive smart phone and other stuffs is to avoid paying more sales tax. Japanese government raised sales tax rate to 8% from 5% in this April. My question is whether it is the appropriate time to raise sales tax now in Japan.

I worry that this increase of sales tax is very likely to weaken Abenomics to stimulate Japanese economy. As tax increases, disposable income decreases and consumption will also decrease. The Wall Street Journal also pointed out that, in the past, Japan already experienced serious decrease of consumption due to the increase of sales tax. In 1997, Japanese government increased sales tax rate to 5% from 3%, and this hurt consumption along with the effects of Asian financial crisis.

The main reason for the increase of sales tax is to reduce huge pile of Japanese government debt, which is more than double of its GDP. As we can see from debt crisis of some peripheral euro countries, debt crisis severely hurts economy. Credit rating agencies also has kept pointing out debt problem as a major negative factor in Japanese economy.

debt

But, I think that more urgent issue for the Japanese economy is to escape from deflation and stimulate consumption rather than to reduce government debt. With aggressive economic policy aka Abenomics since end of 2012, Japanese economy showed some signs of recovery. However, unemployment rate in Japan still seems to be over natural level and CPI is also still very low as shown in the below graph. So, economy surely needs to be supported more by strong stimulus policies.

cpi umemployment

Also, Japanese government should focus on stimulating the consumption more because, in spite of sharp depreciation of real exchange rate induced by Bank of Japan’s easy monetary policy, net exports does not respond much to this. In the meantime, consumption is becoming more important as share of house consumption in GDP keeps increasing trend in the below graph.

current account exchange rate

household consumption

Also, in spite of its huge size, Japanese government debt does not seem to be an immediate threat to Japanese economy. It is known that, in Japan, majority of government debt is held by its own people not by foreign lenders. Outstanding international public debt securities to GDP keep decreasing. So, Japanese government debt is more stable than other countries’ debt which have large share of foreign lenders. Furthermore, Japan is the second largest reserve asset country in the world after China with more than one trillion dollars of reserve asset. I think that Japan can wait for more favorable time to manage its debt problem more effectively.

reserve

When solving problems, we need to start to address the most urgent issue first and then move to other issues. Considering current economic situations, keeping economic stimulus is more urgent and timing of raising sales tax is not right.  Japanese government can solve government debt problem more effectively when economy is in better shape. They can raise tax more easily with less damage on the consumption and general welfare of its people after economy gets better.

Some criticize Abenomics for its easy money policy. Also, export competing countries with Japan complain about its easy money policy and depreciation of Japanese Yen. But, I think this Abenomics is quite reasonable policy choice from the perspective of Japanese government. So, I worry that this tax increase may cause more harm than good for Japanese economy weakening Abenomics.

 

 

(Revised) New Chapter in Abenomics

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

It is hard to talk about Japanese economy without discussing 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 exogenous supply shocks. The central bank also loses control over its monetary policy instruments. Even with the lowest interest rate of 0% since way back, 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 at the lower end.

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 by that 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. One of the things that Japanese government did when they faced the real estate bubble deflating was to spend a lot. How did this work out for Japanese?

In terms of today’s goals, this is part of Abenomics’ goal. Although they are still heavily indebted, they wanted to do the extra mega-spending in fiscal policy and even looser monetary policy in order to override the deflation they were experiencing.  The fiscal burden as you can see have been growing at a very fast pace. 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 is still very unpredictable. There has to be more of tax raise and other spending cuts in order to deal with the debt in the coming years, but it is still unclear whether the net effect of Abenomics would be positive.

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 are in international trade competition with Japan–countries like EU, South Korea, etc.–complain that it is very unjust for them to play the beggar-thy-neighbor approach.

I personally think that what Abe’s government did has no moral culpability per se. 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 shoot for a comeback to their heydays growth level. They are running out of fiscal policy options with enough deficits in hand already. Monetary policy had been inoperative for many years and even more so now perhaps. To me it seems like Abenomics took the eat-a-lot-now-and-fast-later approach, and hopes that what they had eaten will last long after their fasting period. As Japan just begins their fasting period, they can only hope that their momentum will last

Japan’s increase in sales tax – right decision?

In my previous blog post Japanese economic growth – now time to stimulate export, I wrote about how Abenomics has not been successfully increasing the Japanese export. Furthermore, I was concerned about Japanese economic recovery, as Japan’s recovery is mainly driven from increase in domestic consumption. In April 1st 2014, Japan’s domestic sales tax rose from 5% to 8%, as forecasted in October 2013. Japan’s Prime minister Abe Shinzo’s aggressive monetary policy did help Japan to escape from its continuing deflation, and I am worried if this rise in sales tax will go against Abe’s monetary policy.

According to the Wall Street Journal article Japan’s Sales-Tax Boost Will Test Abenomics, Japanese government’s decision to increase sales tax worries many economists. As it can be seen from the graph below, Japan have once increased its sales tax in 1997 from 3% to 5%. The result was disappointing, as Japan suffered from a decrease in consumption and continuing deflation and recession for more than 18 months. Bank of Japan forecasts that Japan’s Consumer Price Index will be at its steady rise of 1.3% for remainder of 2014 and then reach its target rate of 2.0% by 2015, while private economists forecast that Japan might go back to its long-time deflation, with rate lower than 1%.

EI-CG569_OUTLOO_G_20140330160004

The article from Reuters Abe bets he can break Japan sales tax jinx with April 1 rise points out that the main reason for this increase in sales tax is to curb Japan’s massive public debt. Jesper Kroll, head of equities research at JP Morgan insists that “2014 is not 1997”, saying the probability of success (in rising sales tax) is better than ever. He cited a tight labor market, increased household and small-business burrowing and a $53.44 billion extra budget enacted in last December will cushion the impact of the sales tax rise.

However, I am still concerned about this tax rise. As I have already mentioned in my previous blog post Japanese economic growth – now time to stimulate export, Japan’s economic recovery in 2013 was driven from domestic consumption (not international trade) despite aggressive Abenomics. While Yen is still strong, Japan’s export is unlikely to boost in a huge amount in 2014 as well. Therefore, if Japan’s domestic consumption is reduced due to an increase in sales tax, then it is probable that Japan will be unable to maintain the fast rate of economic recovery from 2013. Therefore, I think it is extremely important for Japanese government to keep an eye on Japanese economy (especially its domestic consumption and CPI index) and execute necessary monetary and fiscal policies if increase in sales tax goes to an opposite direction to where Abenomics is heading.

Japan Boosts Sales Tax, May Test Abe’s Policies

Japanese citizens across the country have been rushing to the malls and supermarkets ahead of the sales tax increase this Tuesday. According to George Nishiyama of the Wall Street Journal, Japan plans to implement a sales tax increase from 5% to 8%, which was designed to help pay for the nation’s exploding social welfare costs and public debt. It is expected that citizens will begin to rein in their spending habits after the tax increase, which appears to contradict Prime Minister Abe’s plan to stimulate the economy. As Nishiyama points out, in 1997, the last time Japan initiated a sales tax increase from 3% to 5%, Japan ended up plunging into a recession lasting 18 months. He also points to a poll by the Kyodo new agency that suggests that

“66% of respondents plan to cut spending, while 33% said they don’t plan any changes. Nearly 80% expressed worry about the economic outlook.”

Overall, Nishiyama seems to suggest that the sales tax rise may be dangerous, in that it could contribute to factors leading to a failure by Abenomics to lift the economy, which in his words “has already faced criticism that it is a policy of exiting deflation by creating a bubble through easy money at the expense of ordinary Japanese.”

Whether this was a causal relationship is yet to be seen, but in any case it seems as though there may be unforeseen consequences of issuing sales tax increase is arriving at the wrong time, and, on one hand, that it has the potential to weaken Abe’s efforts to boost the Japanese economy.

On the other hand, the Economist appears more impartial than the Wall Street Journal to the idea of the sales tax increase, considering fiscal consolidation over the longer term a “fourth dart in the quiver” against Japan’s anticipated financial woes. According to the Economist, Japan’s national public debt issue is one of them most pressing problems in the Japanese economy, as the national debt is anticipated to exceed 240% of national GDP later this year. The Liberal Democratic Party of Japan (LDP) last year cooperated with the Democratic Party of Japan (DPJ) to pass the sales-tax bill. This will reportedly increase the sales tax from 5% to 8% this April, and to 10% in October of this year. Prior to Prime Minister Abe’s inauguration, this policy initially looked like it would help get the country on track; it would reportedly cut the Japanese budget deficit to around 3.2% of GDP. This was, of course, before Prime Minister Abe’s stimulus package that would make hitting the 3.2% of GDP target improbable.

The authors don’t appear very worried about the potential negative effects of Abenomics on the  Japanese debt market. They mention that yields on Japanese government bonds (JGBs) are currently historically low, and that the market for the bonds is dominated by Japanese savers and institutions, which are more loyal and less “flighty” than foreigners who would demand high yields. This would make it less likely that there would be a rapid escape from Japanese bonds over worries that the nation could not pay its debts, and therefore may make the market more stable. Furthermore, the Bank of Japan is currently purchasing 70% of new JGBs issued annually. Essentially, much of Japan’s debt is being paid for with money that the Bank of Japan prints, that the rest is mostly in the hands of Japanese citizens, and that this is not an immediate problem. The economist also points out that while Abe’s policies may hurt Japan in the near-term, that it should boost economic activity, both raising tax revenues and making it easier for the government to raise the consumption tax.

If I were forced to pick a side, I’d stick with the Economist on this issue. First, like in many situations in Economics, it’s difficult to discern causality between events, especially one time events. This throws a bit of doubt into whether the tax increase would inevitably lead to further financial problems for the Japanese economy. The tax increase would mean that Japanese citizens would have less disposable income to spend on consumption, but Abe’s current stimulus policy may be large enough to take the edge off and could make it less likely that a subsequent recession will occur. Furthermore, it may be advantageous use the increased tax revenues to wind down the Japanese debt problem now rather than later. As another Economist article points out, the Japanese also face an aging population that in the near future will begin to withdraw money from their retirement plans. This will mean that the national savings rate could decrease in the near future and make it difficult for the Japanese government to find able citizens to buy up its debt. A tax increase now may be a proactive way to reduce this burden before things get bad. Of course, this is a contentious issue in Japanese politics, and the effects of Japan’s current policies are uncertain, so in the end it will be important for both sides to proceed cautiously.

 

Sales tax increase in Japan

The Wall Street Journal introduced some interesting story of Hideo Noda, an ordinary Japanese office worker, who recently bought expensive smartphone and other stuffs. The reason why he suddenly went shopping those goods is to avoid paying more sales tax later. Japanese government will raise sales tax rate to 8% from 5%. My question is whether it is the appropriate time to raise sales tax now in Japan.

I worry that this sales tax increase is very likely to hurt recovery of Japanese economy and, weaken Abenomics to stimulate Japanese economy. As we learned from basic economic theory, tax increase will cause consumption and output to decrease as disposable income decreases. The Wall Street Journal also reported that in the past, Japan already experienced serious decrease of consumption due to the increase of sales tax. In 1997, Japanese government increased sales tax rate from 5% to 3% and this really hurt consumption along with the effects of Asian financial crisis.

The main reason for the increase of sales tax is to reduce huge pile of Japanese government debt, which is the largest among the advanced economies. As we can see from the examples of other countries like some peripheral euro countries which are suffering from debt problems, debt crisis can really hurt its economy. But even though the government debt is a serious problem in the Japanese economy, I think that more urgent issue for the Japanese economy is to escape from deflation and stimulate consumption.

Japanese government can solve government debt problem more effectively when economy is in better situation. They can raise tax more easily with less damage on the consumption and general welfare of its people after economy gets better. Normally, when economy is in boom, government tax revenue increases even without increasing tax rate. Also, it is known that, in Japanese case, majority of government debt is held by its own people not by foreign lenders. This contribute to reduction of possibility of debt crisis in Japan. And Japanese government can use easy monetary policy to easily revolve its debt by making Bank of Japan buy more government bonds. So, having a large debt is not such an immediate threat to Japanese economy.

With aggressive economic policy aka Abenomics since end of 2012, Japanese economy showed some strong signs of recovery with 4% growth in the first half of 2013, and also began to escape from deflation with the consumer price recording a rise of 1.3% in February for the three consecutive months.

Some criticize Abenomics for its easy money policy. Also, export competing countries with Japan complain about its easy money policy and depreciation of Japanese Yen. But, I think this Abenomics is quite reasonable policy choice from the perspective of Japanese government. So, I worry that this tax increase may cause more harm than good for Japanese economy.

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.

 

“Kurodanomics”

Japan has often been touted as the most successful recovery for a developed economy since the recession of 2008.  Many economists have laid the benefit of Japan’s recovery at the feet of Prime Minister Shinzo Abe, calling Japan’s economic recovery “Abenomics”.  I recently read an article about Japan’s that I found to be particularly interesting.  Before the recession, Japan had been going through massive deflation.  The interest part about this, is that for 15 years, prime ministers, finance officials and lawmakers have told the public that it was the Bank of Japan’s fault for not doing more.  This thinking led Shinzo Abe to hire Haruhiko Kuroda to run the central bank.  It was Kuroda’s decision to implement the very things Abenomics is being praised for.  With Kuroda at the head, the Bank of Japan rose the monetary base to 270 trillion yen. Unfortunately, like many other easing programs in the post recession world, the increase in the monetary base did not lead to the increase in living standards even though the Yen has fallen 20%.  The failure of the increased monetary base illustrates that Japan’s problems can’t be solved by just monetary policy.  Japan’s aging population and China’s raising influence are examples of influences that monetary policy can’t solve.  It is unfair to criticize Japan’s BoJ policies if fiscal policy isn’t being implemented as well.

This past week, the head of the BoJ called on the prime minister of Japan.  The lack of the increase in exports illustrates how the Prime Minister needs to look at lowering corporate tax rates, lowering trade barriers, stimulating innovation and opening the labor markets.  The Bank of Japan is still likely to hit its 2% inflation target and with rates being close to the zero bound, its now the governments time to act.  Kuroda is worried that if the government doesn’t take fiscal action, “the long term interest rates will rise out of line with economic fundamentals”.  This coupled with Japan’s widening trade gap, illustrate increasing problems that the Bank of Japan have very few resources left in its arsenal without fiscal help.  Without the fiscal help, Japan could see a flight of foreign capital that could remove the 57% increase of the Nikkei that Japan witnessed this past year.  Until the Bank of Japan has the ability to use negative interest rates, I believe that the government needs to step in to increase domestic production since the low interest rates have not helped as much as necessary.