Synopsis: A look at Japan’s economy and a discussion about how best to improve it

​Click here to read the original article.

Discussion:

This article discusses the ways in which Japan could improve its economic situation, chiefly through fiscal and monetary policy.

Krugman highlights aspects of the Japanese economy that are encouraging: “Output per working-age adult has grown faster than in the United States since around 2000, and at this point the 25-year growth rates look similar”, and “… Japan is closer to potential output than we are”. Nevertheless, Japan is struggling to escape from deflation. Why has Abenomics not worked as well as people hoped?
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The main ideas in his article are best portrayed through a flow chart:

1. According to Krugman, the two biggest issues are Japan’s over-reliance on fiscal expansion (which leads to a high debt-to-GDP ratio) and its chronic deflation. Fiscal consolidation may be called for to balance the debt-to-GDP ratio and to reduce Japan’s reliance on fiscal expansion, but Japan has no way of offsetting the effects of fiscal consolidation through QE; after all, the interest rates are already as low as can be.

2. It follows that one of the only solutions is to raise inflation such that real interest rates fall. This way, QE can happen alongside fiscal retrenchment. Krugman adds as a side note that raising inflation would also reduce the value of debt.

Krugman describes how Japan may be facing a negative Wicksellian rate (explained under ‘key terms’) as a permanent condition. He points out that even if the Bank of Japan were to promise greater QE, it is ultimately consumer expectations of future inflation that will determine inflation (more about this will be explained under ‘context’).

Krugman’s solution is to combine monetary policy with a burst in fiscal stimulus. The fiscal stimulus will raise the inflation, and the increase in inflation leaves room for more QE. Only when more QE is enacted can fiscal consolidation occur, which would cut down the debt-to-GDP ratio.
The question, then, is how high should inflation be? While the answer does not have a certain numerical value currently (i.e. it has to be high enough to allow QE to occur), it is clear that Japan’s 2% inflation is not enough.

Krugman emphasizes the problem of fiscal consolidation alone: it may cause an economy slump, in which case Abenomics may be beyond redemption. He says that the only measure left is for Abe to engage in aggressive austerity and QE together to increase inflation.
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Key terms:

1. Wicksellian rate (a.k.a. natural rate of interest): Kurt Wicksell was a leading Swedish economist who was best known for his idea of the natural rate of interest. The theory suggests that there is a long-run natural rate of interest, and if the current rate of interest is higher than said natural rate, there will be deflation, and if the current rate is lower than the natural rate, there will be inflation. When the current interest rate equals the natural rate of interest, there is equilibrium in the commodity market and price levels are stable. To read more about this (and how it pertains to modern-day economics), click here.

Context:

1. To understand this article, it is important to understand what Abenomics is. Abenomics is a portmanteau of the words economics and Abe – Shinzo Abe being the Prime Minister of Japan. His plan is to fire three ‘arrows’ to stimulate economic recovery. The first arrow is expansionary monetary policy in the form of QE, the second is fiscal stimulus, and the third is structural reforms, mainly through strengthening the Japanese army.

While these three arrows seem like feasible ways to revive the economy, Japan is still faced with lacklustre inflation, and many attribute this to the fact that Abe is not aggressive and hawkish in any of his three tactics, or arrows. Paul Krugman discusses what Abenomics’ next steps are.

2. How does future inflation determine inflation today? Consider this situation: a consumer in an economy wants to buy a new phone. She believes that inflation will increase in the future, i.e. the price of the phone will be higher in the future than it is currently. For this reason, she buys the phone today. Many consumers in the economy also believe that future prices will be greater than current prices, and buy the goods and services today instead of waiting for the price to increase. The aggregate demand in an economy suddenly increases, and producers increase the price of the goods and services in an economy as a response. This increase in prices of goods and services is, in fact, inflation. Deflation works in a similar way. In this way, inflation (or the lack thereof) is a self-fulfilling prophecy.
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3. In my opinion, there are a few problems with Krugman’s proposed solution. The first is that despite years of fiscal expansion by the Bank of Japan (BoJ), deflation still persists. Even aggressive fiscal expansion, which is what Krugman suggests, has its problems. Firstly, there is no telling when the aggressive expansion will result in a sufficient level of inflation; it could take much longer than the BoJ can afford, and it will exacerbate the debt-to-GDP ratio greatly. Secondly, even when the BoJ deems the inflation level in Japan as healthy enough to allow fiscal retrenchment to happen, they have to be wary of consumer expectations. Either the BoJ will have to execute fiscal consolidation so slowly that it now faces high inflation and a high debt-to-GDP ratio, or it will have to carry out fiscal consolidation quickly enough to avoid inflation from becoming a worry. The problem with the latter is that consumer, investor and producer confidence in the market is shaky enough as it is; fiscal consolidation may scare them enough to revert the economy back into the original state of deflation where people are hesitant about consumption, production and investment.

Synopsis: An article on how demography (age) affects inflation.

Click here to read the original article.

Discussion:

This article discusses the link between inflation and demography. Ageing populations leads to “slower growth, because a country’s potential output tends to fall as its labour force shrinks.” They also have to face heavier fiscal burdens because governments must provide for more pensioners from fewer taxes. Given its ageing population, this is a big problem for Japan.

Many economists take persistent deflation in Japan as evidence to show that prices fall when counties age, and consequently, growth slows. The Prime Minister of Japan, Shinzo Abe, has tried disproving that link by increasing inflation through aggressive quantitative easing. However, as inflation has yet to reach the targeted 2%, the tempting conclusion is that ageing populations cause deflation.

Recent research has sought to disprove that link.

It is important to not just see the links between ageing and prices, but the way they cut. In terms of the factors of production, when growth slows, businesses reduce investment so that the cost of capital can decline. However, wages should rise when the supply of workers falls. And in terms of government action, some governments reduce their spending on other projects to support pensioners, causing slow growth and sluggish inflation. Other governments, however, may decide to monetize their debt, pushing inflation up.

The article disentangles all these possibilities to descry a clearer link between an ageing population and inflation.

This article states a few main points:

1) In a recent paper by Mr. Katagiri of the Bank of Japan and Mr. Konishi of Waseda University distinguished between an ageing population caused by lower birth rates and an ageing population caused by increased longevity.

a. Fewer births would lead to a smaller tax base, encouraging governments to “embrace inflation to erode its debts and thus stay solvent”. This will be further explained under ‘context’.

b. Longer lives would cause the ranks of pensioners to swell, along with their political influence. Their influence would augur for “tighter monetary policy to prevent inflation eating into savings”. This will also be explained under ‘context’.

Messrs Katagiri and Konishi believe that the latter (increased longevity in Japan) has caused deflation of about 0.6ppt over the past 40 years. Therefore, it is not just ageing that has caused deflation, it is more longevity.

2) This article then looks at the impact of ageing on financial assets. The “life-cycle theory” suggests that people average out their consumption over lifetimes: “going into debt when young, buying assets when their earnings peak and selling them to pay for retirement”. In theory, it should lead to lower asset values, but in practice, while house prices often fall, stocks rise.

One important aspect is whether the assets sold are domestic or foreign. Messrs Anderson, Botman and Hunt of the IMF found observed the decrease in Japan’s net saving rates from 15% to 0% of disposable net income from the 1990s to 2011. Many of these savings are invested in foreign assets, and when retirees repatriated their funds after selling stocks and bonds abroad, the yen appreciated. This, in turn, causes deflationary pressure by lowering the cost of imports. This can be negated by “strong monetary easing combined with a credible commitment to an inflation target”. In other words, Abenomics.

3) A recent paper by Messrs Juselius, and Takats from the Bank for International Settlements offers a vastly different explanation for how ageing affects inflation, pointing out that Japan may be quite atypical. They observed 22 advanced economies from 1955 to 2010, and found a steady correlation between deflation and demography, even though just the opposite is assumed. They found that a larger share of dependents is linked with higher inflation, while lower inflation is linked with a higher labour force. Their explanation for this is that countries that consume goods more than they produce them (i.e. with a smaller labour force) causes excess demand, and thus, inflation. However, countries that consume less than they produce causes excess supply, and thus, deflation.

This then begs the question of why Japan has such low inflation. Some possible explanations are damaged balance-sheets caused by the asset bubble pop in the 1980s, or the tentative and hesitant Abenomics.

Context:

1) Why does the government need to make “painful cuts as pensioners multiply”? And what does it mean “monetise their debt”? Number 1 is for the former, and number 2 is for the latter.

2) Why would embracing inflation erode a country’s debts? As inflation goes up, the value of the debt goes down in real terms. Therefore, the amount of debt a country owes decreases.

3) In the section, ‘Greyflation’, the article discusses a finding that explains how a larger share of dependents is linked to higher inflation, and how fewer dependents mean lower inflation. I am sceptical about this argument because, if this were the case, what should we expect in the US when baby boomers retire en masse? A spike of inflation? This is contrary to what a lot of people believe.

Synopsis: The effects of and solutions to deflation.

Click here to read the original article.

Discussion:

This article discusses the effects of and the lack of potential solutions to the current worldwide deflation.

Christopher Sims, a Nobel laureate who specialises in causality in macroeconomics (quoted in this article) warns that QE by itself has little effect on monetary patterns, and thus, on inflation. He says that the only reason Anglo-Saxon QE worked at all is because the central banks (BoE and the Fed) “talks a better game” (which, in its essence, is qualitative easing) than the ECB.

The effects of deflation are:

1) Pre-emptive retrenching, given consumer expectations for prices to decrease.

2) Decreased investments and increased savings from businesses who expect a hit.

Overall, the two points above mean that there will be less money circulating the economy. Notice how those two points show that an expectation of deflation causes deflation – these two reasons are the main reasons why deflation is a self-fulfilling prophecy.

Whether QE works to increase deflation can be seen by observing Japan, whose large-scale bond-buying programme is meant to encourage inflation.

Key words:

1) Money indicators: money indicators measure the amount of money in an economy. Different definitions of money supply include cash, or cash and deposits, or checks.

These definitions, according to Investopedia, are:
a) M0: Hard cash and coins
b) M1: M0 + checking accounts, traveller's checks, demand deposits
c) M2: M1 + savings accounts, time deposits (less than $100,000), money market funds

2) Primary surplus: This is where government income – government expenditure > 0 but the interest on the loan has not been paid back yet. For another blog post that discusses the primary surplus, click here.

Context:

What is Sims referring to when he says that the Fed “talks a better game” than the ECB? This is the idea of qualitative easing (more can be read about this here), where the Fed assured the economy that it will do its best to decrease unemployment and increase inflation, i.e. they said that they would carry QE through to the end. I disagree that the ECB doesn’t “talk a good game”. In fact, in 2012, Draghi said that the ECB will “do whatever it takes” to improve the economy. In 2012, many people believed that the periphery Eurozone countries would split from the EU. As a result, borrowing rates for the PIGS countries increased, and confidence in the euro was lost. Draghi responded by saying that the ECB would do "whatever it takes" to save the euro. Because of this, the faith in the Euro was restored and the borrowing rates for the periphery countries dropped. Click here to read the official statement made by Draghi.

Synopsis: With all the different directions that different economies are dealing with their QE, what are the repercussions?

Click here to read the original article

Discussion:
This article discusses the repercussions of the lack of synchronization between the Federal Reserve’s and the Bank of Japan's monetary actions. While the Fed has ended its bond-buying practices, the BoJ has just intensified it. Consequently, the yen fell sharply against the dollar, which will hopefully increase exports and production in Japan, battling its long-lasting deflation. However, this means that other exporters might have to lower prices in other countries to compete in the global markets. The writer thinks that this might cause worldwide deflation. The author then talks about how the stagnant state of inflation in the US (which has not yet capitulated to the worldwide deflation that the writer fears) has caused the gold price to drop. The U.S. and Japan’s central banks’ diverging monetary decisions are causing a rift in the global markets.

I will be summarizing the points made in this article in a flow chart in the next post, as well as problems I am seeing while applying this article to the actual situation in Japan.