Tag Archives: kuroda

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

The Absurdity of ‘Abenomics’ and the PM’s ‘Three Bendy Arrows’ (Part 2: Accounting for Growth)

In my last post on the policy agenda of Shinzo Abe, I took issue with both the Japanese prime minister’s choice of economic growth as almost the sole goal of government, but more importantly his ability to achieve such growth. Indeed, it is my contention that Japan has a post-growth economy, the principal reasons for which are twofold: demographics and diminishing returns to technology.

The above statement can be put in the context of growth accounting. From the OECD Compendium of Productivity Indicators 2012 we see a summary statement on growth drivers:

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.

Next, let’s look at the headwinds to growth cited by the last governor of the Bank of Japan, Maasaki Shirakawa, who hardly ever stepped onto a podium to give a speech without including the following slide in his presentation pack (click for larger image):

Labour Force jpeg

As you can see from the chart above, labour inputs—the red section of each bar—have become a strongly (and increasingly) negative component of growth. The blue section of each bar—which encompasses both capital deepening and multifactor productivity (innovation and efficiency)—has also shrunk substantially.

So if Shinzo Abe wishes to bolster growth he has to do one of three things when he shoots his three policy arrows: 1) increase labour inputs, 2) expand capital inputs or 3) encourage multifactor productivity growth (innovation, creativity and organisational efficiency). Continue reading

The Absurdity of ‘Abenomics’ and the PM’s ‘Three Bendy Arrows’ (Part 1: What Is He Trying to Achieve?)

Although Japan has been eclipsed by the European southern periphery for the title of the world’s foremost post-growth economy, it still matters for its sheer economic size  (currently number three in the world behind the U.S. and China). However, despite sneers over Japan’s lost decade (or decades), the country has managed its decline rather well.

True, its outlying prefectures are peppered with depopulated and dilapidated towns and villages (beautifully chronicled in the past by Richard Hendy in Spike Japan), but there is none of the social implosion of, say, a Detroit or an Athens. Moreover, the Anglo-Saxon sniggers appear increasingly misplaced since the credit crisis hit, at which time the ephemeral nature of growth was recognised throughout the OECD.

Nonetheless, the election of Shinzo Abe in December 2012 has given rise to a resurrected style of evangelical “yes we can” style of politics (for veterans of Japan, we have been here before with Hosokawa and Koizumi). My preferred reply to Abe’s exultation would be this: “no, we can’t”, supplemented by “why are we even trying?”

So what exactly is Prime Minister Abe trying to do, especially as it has already been honoured with its own name: ‘Abenomics’. If you want to get an overview of Abenomics, you can find a short four-minute video on the subject from The Financial Times here.

First and foremost, he wants to invigorate growth (as a philosophy, this is about as novel as wanting peace on earth) through a ‘three arrows’ agenda of monetary stimulus, fiscal stimulus and structural reform . Quite why he wants more growth is never really explained. Perhaps it will help reduce government debt. But government debt is an intermediate outcome. How many people wake up in the middle of the night and say to a partner “I can’t sleep darling, I am so worried about the government’s debt.”

What people really worry over is whether they 1) can buy stuff such as food, housing and toys (like iphones, SUVs and foreign holidays), in accordance with their expectations 2)  are healthy, 3) have status (which starts by having a job), 4) have agency (which means the ability to have some degree of control over one’s job, environment and life outcomes, 5) have a partner, 6) have friends, 7) feel part of a broad, safe community,  8) get enough sex, again in accordance with expectations, and 9) have thriving children (for parents).

When Abe says, in all his munificence, that he wants to bestow on the people of Japan the gift of growth, he is saying that this gift will make people happy. But he is not saying through which avenue of growth this happiness will be attained. Will raising Japan’s long-term potential rate of growth provide people with enough sex to fulfil their expectations (a sure fire way to make people more happy)? I doubt it. Will it allow them to make new, close friends? You get my drift.

But hang on, you say, it will give them more toys! Perhaps. But then we are in a situation of who gets the toys and whether in the process of getting more toys the actions taken impair some of the other variables relating to happiness. I will come back to this point when I look at Mr. Abe’s ‘three bendy arrows’ agenda in more detail (in a later post).

So putting aside the question of whether growth will actually make the people of Japan happier, the next question is whether Abenomics can achieve the wished-for growth? To answer this question, let’s start by sneaking into the hallowed halls of the Bank of Japan (something I also used to do 20 plus years ago when I edited some of the most boring reports known to mankind). In his quest for the Holy Grail of growth, Prime Minister Abe has appointed a punditry applauded New Model Central Banker (NMCB), Haruhiko Kuroda. I, however, personally pine for his dull, dour predecessor Maasaki Shirakawa. Why?

Now Shirakawa never said that growth was not a good thing to strive for. See this statement from his final speech as Bank of Japan governor, given to the Japan Business Federation.

Needless to say, the ultimate aim of economic policy is to raise the living standard of each citizen. While there is no single indicator for gauging people’s quality of life, if we were to put this in approximate terms, the key aim of macroeconomic policy is to raise the per capita consumption level, or to raise the real gross domestic product (GDP), which is closely related to the former, in a sustainable manner.

Personally, I believe that in response to the request “Please sir, can I have some growth?” Shirakawa should have been more honest and given this reply:

No, tough shit, you are not going to get any growth, so there.

And in so doing, he could have conveyed the more meaningful message:

Rather than pursue something you can’t have, why don’t you all move on and do something more useful with your lives—something that will actually make you more happy.

Why do I say this? Because at the back of almost every Shirakawa speech is a set of charts clearly demonstrating that there is no growth to be had. As an example, I will plunder Shirakawa’s chart book from his last speech (given in February 2013) because the numbers are up-to-date. Many if not most of his speeches, however, have similar slides, so it doesn’t really matter which speech you pick.

First, we see that Japan’s growth rate has wilted over the last few decades:

LT Japan Real Growth jpeg

And this has been driven by declining productivity and poor demographics.

Labour Force jpeg

We also note that Japan’s productivity is not that bad in comparison with other major OECD countries.

Japan Productivity jpeg

Further, if we compare Japan’s record on a like-for-like basis with other economies—that is, correcting for the impact of demographics—then employee-adjusted GDP looks perfectly respectable:

Adjusted Growth jpeg

And just to remind ourselves, I will show a chart from a Japanese Ministry of Health, Labour and Welfare (MHLW) presentation that demonstrates just how bad the demographics will get:

Populaton Trends Japan jpeg

After this short series of charts, we know exactly what Prime Minister Abe’s  ‘three bendy arrow’ policy agenda is seeking to achieve. He is seeking to overcome a roughly 1% per annum drag on growth from fixed demographics. So to get 1% real GDP growth, his ‘three bendy arrows’ will need to double productivity growth; and to get 2% real GDP growth, they will need to treble productivity growth. Also, he is aiming to do this at a time when all the OECD countries have seen decadal declines in productivity, and not one advanced country is consistently recording 2% plus rates of productivity growth in the current climate.

I will argue in my next post that the achievement of such huge jumps in productivity growth are an impossibility. What is more, in trying to attain what cannot be attained, Abe risks setting off a range of unintended consequences that could harm happiness, and, counterintuitively, whatever economic stability Japan has been able to achieve in recent decades.

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