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This article discusses the problem Abenomics is facing, and focuses on the problems with Japan’s falling GDP, rising debt and stagnant inflation.
The general plan of Abenomics was as follows:
1. Aggressive QE (bond-buying programs) should increase inflation expectations
2. The rise in inflation expectations would lead to an increase in wage inflation and nominal GDP growth, which means confidence would be instilled in the market. A tightening of fiscal policy (i.e. increased sales tax) should therefore not break the confidence.
Clearly, the second step has not been achieved, as seen by the low nominal GDP growth.
The question now is whether fiscal policy should be tightened. The IMF believes it should be, stating that they fear for Japan’s increasing debt, but Paul Krugman, Lawrence Summers and the author of this article, Gavyn Davies, disagree. They warn Abe that tightening fiscal policy prematurely, when the economy is recovering, might push the economy back into a recession. Davies adds that delaying the sales tax increase will not exacerbate the debt/GDP ratio like the IMF fears; it will only increase it by 0.75 percentage points from the already existing 245%.
From this, we can see that Abe is facing a dilemma; on one hand, he can increase austerity measures (contractionary fiscal policy) and alleviate the government debt. Resultantly, consumer confidence will break, which, according to Krugman, will push the economy into a recession. On the other hand, Abe can focus on QE (expansionary monetary policy), thereby increasing government debt but solidifying consumer confidence. The IMF feels as though increasing government debt is an issue that must be tackled in the short term. Davies disagrees.
1. Inventory shredding: This phrase is seen in the second paragraph of the article. It means to bring down the inventory. For example, if Mrs. X runs a cupcake shop and she has made 100 cupcakes, of which 5 were bought, she might stop producing cupcakes to sell off the remaining 95 of them. Selling off her excess inventory of 95 cupcakes is called inventory shredding.
What does Davies mean when he says that “nominal bond yields had to be held down as inflation expectations increased” (paragraph 7)? The purpose of holding down nominal bond yields is to decrease the value of real bond yields.
Just like with interest rates, where nominal interest rates = real interest rates + inflation:
Nominal bond yields = real bond yields + inflation
So, if nominal bond yields stayed the same, and they expected inflation to increase, then the value of real bond yields would decrease.