Tag Archives: japan

The Absurdity of ‘Abenomics’ and the PM’s ‘Three Bendy Arrows’ (Part 4: Bubble Economics)

As I write this post, the yen has broken below 100 to the U.S. dollar and the Nikkei has closed at a five-year high. So surely Abenomics is working, isn’t it? Well, it is certainly pushing up asset prices. Indeed, if I were still in my old job as a Japanese equity hedge fund manager I would have swung the bat as hard as I could after Bank of Japan Governor Kuroda’s original April 4 announcement. And I would plan to keep swinging the bat well into the future. Indeed, if my risk manager was not having a heart attack by now, I would feel I had not done my job properly.

Strange as it may seem, this is the logical path to follow given that Kuroda has based his analysis lock, stock and barrel on New Keynesian monetary theory. The two canonical papers that sit behind this are Paul Krugman’s “It’s Baaack! Japan’s Slump and the return of the Liquidity Trap” and Gauti Eggertsson and Michael Woodford’s “The Zero Bound on Interest Rates and Optimal Monetary Policy”. The Eggertsson and Woodford paper, which we can think of as Krugman 2.0, has become the intellectual bedrock for the Fed in fighting deflation and is much quoted by Fed Governor Ben Bernanke.

Both papers are difficult reads for the non-economist, but, as I mentioned in my previous post, the Richmond Fed has made available a “A Citizen’s Guide to Unconventional Monetary Policy” for non-specialists that contains the core policy prescription of the two academic papers referred to above.  From A Citizen’s Guide, the critical passage is this:

In the Eggertsson and Woodford model, the com- mitment to making monetary policy “too easy” would only stimulate economic activity if the commitment is viewed by the public as highly credible. That is, markets must believe that the central bank will, in fact, hold rates “too low” in the future simply because it promised to in the past, despite the fact that at that point, it would wish to raise rates to avoid inflation.

Krugman, ever the wordsmith, put this more succinctly:

The way to make monetary policy effective, then, is for the central bank to credibly promise to be irresponsible…

Now we now that asset price inflation operates on a different time scale to consumer price inflation: indeed, Japan’s stock price indices are already up 50% from their December lows, while consumer price inflation has barely budged. Nonetheless, to whatever level asset prices go, Kuroda has to keep his mouth firmly shut to have any chance of the changing public perceptions of future inflation. He is not allowed to make Greenspan-type gnomic references to “irrational exuberance”, let alone pull back from Japanese government bond buying. He must drive Japan’s monetary policy as if he was in one of those defective Toyota cars that was recalled due to a faulty accelerator pedal that got stuck to the floor.

This, of course, is a bubble meister’s charter, since for Kuroda to succeed in changing consumer expectations he must keep the accelerator pedal depressed for years. It is also worth keeping in mind that the Bank of Japan’s newly minted 2% inflation target is only an intermediate goal. As I explained in my last post, what monetary policy is really trying to achieve here is the closure of an output gap, i.e., the difference between where the economy is currently operating and where it could be operating if labour and capital were fully employed.

Moreover, the problem is perceived as one of lack of demand, not supply. The idea is that households won’t spend today because they think goods will get cheaper tomorrow. In effect, even if they hold cash at the bank earning zero, deflation means that they are getting a comfortable real return. The policy goal a la Krugman, Woodford and Eggertsson is to make that real return negative. And the only way to create a negative real return when interest rates are zero is to have inflation. If you can persuade the populace that inflation is barrelling toward them in the future, then they will cut savings and increase consumption now—or so the theory goes.

In addition, if the economy is idling below potential with unused capital and labour, any sudden jump in demand will result in high productivity and economic growth. Growth, in turn, will lead to higher wages and greater government tax receipts. Thus—and this is where the magic of macroeconomics comes in—the act of spending more now results in higher wages and living standards in the future.

Surely, a classic win-win: more consumption and more growth. What’s not to like? Nonetheless, there are a number of problems. First, how smoothly this all works depends to a large degree on the extent of the output gap. An article by Gavyn Davies in The Financial Times takes a look at the difference between output gaps if we just extrapolate past growth and those if we take into account supply side phenomenon (click for larger image) for a number of countries.

Output Gap Measurement jpeg

He explains the graphs in more detail: Continue reading

The Absurdity of ‘Abenomics’ and the PM’s ‘Three Bendy Arrows’ (Part 3: Monetary Policy and a Fictitious Can)

In my two previous posts on Abenomics (here and here), I argued that Japan is a post-growth economy. As the OECD explains in its Compendium of Productivity Indicators 2012, growth can be achieved in only three ways:

Economic growth can be increased either by raising the labour and capital inputs used in production, or by improving the overall efficiency in how these inputs are used together, i.e. higher multifactor productivity (MFP). Growth accounting involves decomposing GDP growth into these three components, providing an essential tool for policy makers to identify the underlying drivers of growth.

Therefore, if I am to be proved wrong in my declaration that Japan is post-growth, Abenomics must be able to boost labour inputs, and/or increase capital inputs and/or improve multifactor productivity (innovation and efficiency). By definition, the Abe agenda must encompass one or more of the three—there are no other means of achieving growth.

Against this background, Prime Minister Abe has given top billing to monetary stimulus within his ‘three arrow’ policy agenda. He campaigned and won a general election on a pledge to force Japan’s central bank, the Bank of Japan, to adopt a binding 2% inflation target through unlimited monetary easing and thus slay deflation. Moreover, to execute such a strategy, he backed a new BOJ governor, Haruhiko Kuroda, who took office in March. Kuroda, in turn, has executed Abe’s monetary policy agenda with gusto. (For a fascinating article on how Kuroda deftly manoeuvred the BOJ board into unanimously support the policy shift, see this Reuters’ article here).

In contrast with the speeches of his predecessor, Masaaki Shirakawa, Kuroda’s early utterances have been accompanied by a very thin chart pack dominated by the now famous ‘all the twos’ slide (click for larger image):

BOJ Quantitative Easing jpeg

These measures will give rise to an extraordinary jump in the monetary base over a two-year period from ¥138 trillion at the end of 2012 to ¥270 trillion at the end of 2014. In fiscal 2012, Japan’s GDP was estimated at approximately ¥475 trillion in nominal terms, so the monetary base is targeted to rise from around 30% of GDP to 55% of GDP.

Monetary Base Target jpeg

By contrast, the action by the Federal Reserve Board in the U.S. looks positively cautious (here), with the monetary base a modest 17% of GDP. Continue reading

Question for Japan’s Kuroda: How Shall We Bugger Off, Oh Lord?

As I write this post, I am looking out at a Tokyo skyline the day after the most radical ever experiment in Japanese monetary policy was announced. The new central bank governor, Haruhiko Kuroda, has promised to double the monetary base over the course of two years and buy government bonds. And if that doesn’t do the trick of reigniting inflation, then he will buy some more.

In and of itself, doubling the monetary basis is meaningless in terms of GDP unless it translates into an expansion of credit. That is credit  to households (allowing greater consumption), to corporations (allowing greater investment) or to government (allowing greater public spending),.

The assumption behind all of this is that Japan’s current rate of economic growth—basically close to zero—is ‘unnatural’. In other words, despite Japan’s ageing demographics, stagnating productivity gains and negative exposure to the long-term upward trend in commodity prices, Kuroda believes that Japan still deserves to grow at 2% per annum or so.

In your dreams.

To be effective, Kuroda’s approach requires a transition mechanism between the monetary economy and the real economy. Given he is buying assets, that transition mechanism rests with the asset markets. But what he ultimately wants to influence is a flow, that is GDP, not a stock, that is asset prices. Putting the government to one side, Kuroda’s game is to crowd out individuals, banks and corporations from the Japanese government bond market. His clearly stated goal is to ignite 2% inflation, but his specific policy tool is to keep interest rates close to zero all along the yield curve to as far out as 40 years. So he is saying loud and clear: “Bugger off out of government bonds or else I’ll inflate you away!”

“Be careful what you wish for,” I mutter to myself.

For a start, he must be careful that they “bugger off” in an orderly fashion. If everyone “buggers off” en masse all at once—and the Japanese do love a craze— Kuroda ends up owning the Japanese bond market. Last week, the Bank of Japan published its latest ‘flow of funds’ comparing Japan with the U.S. and Euroland (click the chart for larger image). As you can see, households, particularly the elderly ones, are clustered in bank deposits. The banks, in turn, invest in Japanese government bonds. So basically the majority of household savings are invested in the equivalent of a Japanese mutual fund for bonds—just at one step removed.

Financial Assets Held by Households jpeg

So, to repeat, Kuroda wants them to “bugger off” out of their indirect Japanese bond mutual fund holdings and do something more constructive  with their money instead. Paraphrasing Monty Python’s “Life of Brian”, the question then is “How shall we bugger off, O Lord?” Continue reading