Why “Will Abenomics succeed?” is the wrong question
There’s a lot of speculation about how Abenomics will work out in the long run. I don’t like much of this speculation, because it seems to conflate four quite distinct questions:
1. Can the BoJ boost nominal aggregates? I.e. is Japan stuck in a liquidity trap?
2. Will the BoJ succeed in reaching its 2% inflation goal?
3. Would higher inflation lead to better outcomes for the real economy?
4. If 2% inflation is achieved, will Japan experience good times?
Before proceeding, let me indicate that I think the answers are:
1. Yes, definitely.
2. Probably not.
3. Probably.
4. Probably not.
Number one is easiest. The BoJ can clearly devalue the yen, and they would not be able to do so if stuck in a liquidity trap. That means, ipso facto, that they can boost inflation and NGDP. There never should have even been a debate on this issue, but if there was it is now resolved.
But I doubt the BoJ will reach an inflation rate of 2%, because the BoJ doesn’t seem committed to that goal:
TOKYO (Reuters) – A rift within the Bank of Japan’s board over how to steer its radical monetary stimulus to end nearly two decades of damaging deflation underlined the early challenges Governor Haruhiko Kuroda faces in his efforts to foster sustained growth.
The differences of opinion were highlighted in the minutes of the April 26 meeting, which showed some policymakers opposed targeting 2 percent inflation in two years and called for more flexibility in guiding monetary policy.
I presume this rift contributed to the recent appreciation of the yen, and the sharp selloff in Japanese equities.
If they do boost inflation substantially, I expect that to lead to significantly faster RGDP growth. But I’m agnostic on whether the growth will be all that impressive. I sort of doubt it. Japan’s problems are probably more on the supply-side. Long term success there will require supply-side reforms.
As far as “good times,” even if the policy boosts RGDP growth it may be seen as a failure. Perhaps the growth spurt will be short-lived. Or perhaps other problems (i.e. fiscal issues) will dominate the headlines. There are far more ways a macro economy can fail than succeed. Most of the time the current situation is viewed negatively by most people. Thus the safest course is to constantly be pessimistic—you’ll sound more intellectual and others will eventually see you as a sort of Nostradamus. “He said it would all end in tears, and he was right.” It’s especially smart to be pessimistic during those rare times when things seem to be going reasonably well, say 1999 or 2005. It probably won’t last long.
PS. An entire post w/o mentioning Paul Krugman! But come to think of it he is almost always pessimistic, even after Obama took office. No wonder he’s right about everything!
PPS. And let’s not forget Tyler Cowen’s “Great Stagnation.” Meanwhile I’m stuck being perceived as a China bull, which means it’s only a matter of time before my reputation lies in tatters. There are no “happily ever afters” in macro.
PPPS. Don’t think resolving the first question is an unimportant achievement. We now know for certain that Japan wasted enormous sums of money on pointless fiscal stimulus over the past 2 decades, in a futile attempt to arrest the relentless decline in NGDP. In fact, all they had to do was try some monetary stimulus. But they never even tried for a 2% inflation target. Until this year.
PPPPS. In contrast, check this out:
“There is no one under the age of 40 now [in Australia] who has experienced a recession as an adult member of the workforce,” said Saul Eslake, an economist at Bank of America-Merrill Lynch in Sydney.
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28. May 2013 at 07:32
Scott, I’m sure you mean that higher NGDP growth would lead to both higher RGDP growth and inflation, right?
28. May 2013 at 07:35
Wow.
I would have thought that, for normal people not caught up in intellectual games, whether this particular policy succeeds or not is pretty important and indeed the right question.
Japan is implementing your suggested policy. If it all end in tears, there should be some pretty good explanations as to why Sumneromics is not responsible.
I find the dodges (“Oh well, they have plenty of supply-side issues, donchaknow”, “oh well, their fiscal situation sucked too much before they started following my advice) disheartening. It seems like a hedge. If it works, you get credit, if it doesn’t, well, it’s not your fault.
My bet? It will end in tears. Yes, they can generate inflation. Incl. that 2% target if they really want. So what? It won’t do anything for RGDP.
28. May 2013 at 07:47
I think the recent burst of growth is short lived. I remember Milton Friedman always saying that the good effects of inflation come first and the bad effects come later. The good effect is when asset prices go up and the “wealth effect” is taking place. The bad effects is when prices start to go up, especially the prices of necessities like food and energy, which have gone up a bit, but will continue to go up as the market starts to price this inflation in.
Japan has way too many structural issues. It has the worst population demography in the world combined with the worst public balance sheet with no solutions in sight. Their debts are 25 times their tax revenues. With issues like that, there is no solution. The question is not if, but when does Japan blow up.
28. May 2013 at 08:15
Frederic Mari: “Japan is implementing your suggested policy.”
It’s true that Japan is finally trying monetary stimulus (after two decades!), which is a step in right direction. But it’s not accurate to say that this (2% inflation target, unlikely to be met) is Sumner’s “suggested policy”. Sumner suggests NGDPLT, to a fixed target, where central bankers are mere technocrats with no discretion.
Don’t pretend that Japan (or anywhere else) is actually trying that policy.
28. May 2013 at 08:18
“An entire post w/o mentioning Paul Krugman!”
Reminds me of, “This sentence is false.” Delightfully self-contradictory.
28. May 2013 at 08:40
A higher measured RGDP now is not necessarily a good thing.
What matters is sustainable RGDP.
If I were building a house that required more bricks than I actually had access to, then even though RGDP is going up, it doesn’t mean what I am doing is a good thing.
If the reason I started building this particular house, instead of something else, was because inflation distorted the coordinating force that independent producers seeking profit “naturally” bring about in a context of free market money, in other words, if inflation made me estimate more bricks are available than there really are, then the argument “Since more inflation boosts RGDP, more inflation is good” would not be true. It would be naive, myopic, and destructive.
Oh but don’t worry, if errors are realize, we’ll just pray for more inflation. That ought to solve the problem of inflation.
28. May 2013 at 08:46
“There is no one under the age of 40 now [in Australia] who has experienced a recession as an adult member of the workforce.”
Right, because when Australians lose their jobs, due to the RBA having to tighten up after a decade and more of unsustainable accelerating money supply inflation, those people are not allowed to call themselves victims of central bank malfeasance, because the “important” statistics don’t apply to them.
As long as we don’t use the WORD “recession”, then “screw the victims” is a valid ethic.
28. May 2013 at 09:01
The BoJ is controlled by the banks which are fatally exposed to low-yielding JGB portfolios. If BoJ succeeds in raising inflation expectations, bond prices will fall and the banks will squeal. Unless govt can immunize banks from JGB prices, BoJ will never be allowed to get near 2% sustained inflation.
28. May 2013 at 10:00
TheMoneyIllusion – Why “Will Abenomics succeed?” is the wrong question…
There’s a lot of speculation about how Abenomics will work out in the long run. I don’t like much of this speculation, because it seems to conflate four quite distinct questions:…
28. May 2013 at 10:03
Professor Sumner,
Not quite related, but here is a Wonk Blog post from Ezra Klein:
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/05/28/why-hasnt-austerity-been-more-of-a-drag-on-the-u-s-economy/
It’s about why the economy is growing despite austerity, and yet there is not one mention of monetary policy or inflation.
28. May 2013 at 10:29
Saturos, Yes, that too.
Frederic. If Japan is destroyed by an asteroid would you blame me?
I’ve consistently argued that the BOJ can definitely boost NGDP, and if they do so it will very likely boost RGDP. I stand by those predictions. I’ve never claimed monetary stimulus would reverse Japan’s demographic decline, which on current trends will entirely erase the Japanese population by 4500.
If you can’t handle nuance, go somewhere else. BTW, Japan is not conducting my preferred monetary policy, which is targeting expected NGDP. It’s not even targeting actual NGDP. But I still expect it to succeed in boosting RGDP.
I never promised Japan a rose garden.
Suvy, You do realize that Milton Friedman favored monetary stimulus in Japan, don’t you? He would be supporting this policy.
Don, That’s right.
Chris, Maybe, but it’s quite possible that 1.5% inflation would leave interest rates stuck at zero.
Thanks J.
28. May 2013 at 12:03
I saw that Ezra Klein piece also and couldn’t believe it didn’t include a discussion of possible monetary off-set.
28. May 2013 at 12:39
Scott,
IMHO.
1. BoJ monetary policy will boost NGDP.
2. Most of the NGDP growth will be real for the first couple of years.
3. Japan will not reach the inflation target for at least a few years if ever because they will be satisfied with the RGDP growth and ease off the monetary pedal.
4. Japan has huge structural problems, but after 20 years of stagnation there’s a lot of low hanging fruit so real growth can be robust for quite a while even if they don’t fix the structural problems.
5. Higher inflation is spawned not by a bigger money supply but rather by higher real growth (or more specifically the expected balance of short/medium term supply and demand). There’s also a hysterisis or path dependency. Years of no inflation has impacted behavior and this will act as a bit of an attenuator on inflation.
28. May 2013 at 14:07
Just for information, the upward shift in the Oz unemployment rate Geoff blames on monetary policy might have something to do with the introduction of tighter labour market regulation in 2009.
28. May 2013 at 14:31
“Just for information, the upward shift in the Oz unemployment rate Geoff blames on monetary policy might have something to do with the introduction of tighter labour market regulation in 2009.”
FDR’s interventions in the labor market had nothing to do with the rise in unemployment during the 1930s.
It was tight money. Friedman and Bernanke and Sumner said so.
28. May 2013 at 18:09
Suvy,
Several commenters have responded to this before with specific reference to the budget/debt numbers. If you really believe this, walk us through the scenario with specific numbers for growth, inflation, tax revenue, debt service, etc.
28. May 2013 at 22:14
What real problems do you think have lead to their almost historically unprecedented stagnation?(serious question, if someone more knowledgeable on Japan would like to answer it)
I see the accelerating nature of their demographics problem as largely being caused by a lack of hope of the people that live there. The way business interact with government is certainly not optimal, but many countries have similar or worse policies without experiencing 20 years of stagnation.
I am a little more optimistic about the effect of monetary policy, but then I believe things can stay very sticky for a very very long time. If you don’t think that stickiness can last for a long time, you should expect only negative effects to the Japanese economy from the stimulus as they should have adjusted by now to their low inflation rate.
29. May 2013 at 03:06
@Don Geddis
Fair enough, I got a bit over-enthusiastic. OTOH, this is closer to ‘print and be damned’ than anything we’ve seen from any of the major CBs, is it not?
@Scott
Maybe I expressed myself a tad too aggressively. Sorry for the offense. Hopefully, I can handle nuance and I plan on keeping reading your blog.
First, though, yes, you’re off the hook if an asteroid destroys Japan. Ditto their demography.
To be honest, when I say RGDP, I usually mean RGDP per capita. After all, what matters/should matter for macro-economists is how wealthy/happy people are. On this measure, as I think you noted, Japan has been far from stellar but not as atrociously bad as often believed.
Thus, my key issue with your writing is the “good times”/RGDP boost stuff.
I mean, I agree (you’ve convinced me) that a Central Bank can target any inflation number it so chooses and that commitment to that target is crucial.
However, I am still unclear on the mechanisms by which NGDP growth converts into RGDP growth (per capita or not). Is it because exports get a boost from currency devaluation? I don’t think that’s your position.
IF I’ve understood you correctly, you expect NGDP to translate into RGDP as consumers/investors start to refuse to hold currency and prefer to buy/invest.
IF (I repeat, I am not actually sure of your position) that’s the main mechanism you expect to be activated, I am still vastly unconvinced. It might work in some situation where there’s maybe a pent-up demand and no real worries about the future (thus, maybe it’ll work in Japan?) but I don’t think that’s going to work in the USA or Europe. There, people who can afford to, save because they’re shit scarred of the future… and with good reasons. Pensions are gone, kids’ education costs are rising fast, health care is expensive, housing is outrageous. In this situation, my suspicion is that inflation works like a tax – You need to make/save even more to achieve your saving objectives, post-inflation…
29. May 2013 at 03:20
If I might, I would make three additional important points.
1. Low population growth is a result not a CAUSE of a stagnant economy.
2. Low population growth is a result not a CAUSE of a stagnant economy.
3. Low population growth is a result not a CAUSE of a stagnant economy.
29. May 2013 at 04:33
Hm. I hear well enough that one would have been enough. And I think low pop. growth can come from a variety of sources, indeed, including stagnant economy/uncertain future.
OTOH, some stagnant economies or countries with uncertain future have had high pop. growth: Africa, Latin America, lots of developing countries in Asia…
I know it’s a cope-out for economists but “culture” comes to mind…
29. May 2013 at 05:12
Rob,
You said;
“What real problems do you think have lead to their almost historically unprecedented stagnation?(serious question, if someone more knowledgeable on Japan would like to answer it)”
High tax rates and regulation. (More specifically, regulations which reduce liquidity in the capital, labor and real estate markets.)
29. May 2013 at 05:52
dtoh, I mostly agree, but I think higher RGDP growth reduces inflation.
Geoff, You really are an idiot. I wrote an entire book explaining how FDR’s labor market policies explain the high unemployment of 1933-40.
Thanks Lorenzo.
Rob and dtoh, The demographics of Japan are definitely NOT due to the slow growth. All the other booming E. Asian countries have demographics as bad or worse. (HK, Singapore, Taiwan, Korea, etc.)
Frederic, I’ve said many times that sticky wages are the mechanism between NGDP and RGDP. If NGDP rises and wages are sticky then RGDP will also rise.
29. May 2013 at 05:57
Scott,
Not all of the demographics. Moderately affluent families tend to have fewer kids. But slower growth makes it worse and it definitely lessens the incentives to immigrate to the country.
Higher growth won’t entirely fix the problem, but it will ameliorate it. If Japan really wanted to fix the problem they could put serious tax incentives in place…. would not be to surprised if this actually happened. (Japanese policy makers are not stupid…. just self serving).
29. May 2013 at 09:01
Dtoh and Prof. Sumner,
Japan’s doomed regardless of what it does. Monetary stimulus can’t save them, nothing can. When a government’s debts get 25 times its revenues, when a government spends 50% of what it takes in on debt service alone, it has no chance. Eventually, a time of reckoning will come where Japan will either be forced to hyperinflate or default, probably both. You can’t keep running 11% fiscal deficits where you spend 50% of revenues on debt service and 68% on social security.
Personally, I think the interest rate spike from the monetary stimulus will create a panic at some point, but I could be wrong about that. Either way, when you have a falling population, falling workforce, a rapidly aging population where your death rate exceeds your birth rate, a debt/revenue ratio of 25, and a debt/GDP ratio of 245%, there is no way to finance that sustainably.
29. May 2013 at 09:27
Suvy,
Walk us through the numbers. What you expect for inflation, interest rates, average maturity of government bonds, NGDP growth rate, tax revenues, debt service, other government expenditures.
Several commenters have done what they think the numbers are and they don’t come to the same conclusion you do. Show us your numbers instead of just repeating the generalizations.
29. May 2013 at 10:27
Dtoh,
How do I think it’ll play out?
In order to keep yields down, the BOJ has had to inject more into the JGB market than it initially projected and yields fell for a time, but they started rising again. However, when you print money, it puts an upward pressure on yields. In order to keep yields down, they have to print more and more in order to get the same effect. So I think there will be more and more selloffs in JGBs that will force the BOJ to come in and suppress yields. Eventually, the BOJ will be forced to peg the yield curve which would require them to keep printing money at an accelerating rate. Eventually, the BOJ and the MOF will be forced between accelerating hyperinflation and default.
As for what interest rates, NGDP, tax revenues, etc in the future; I have no idea. I don’t even know when this thing will blow apart. All I know is that the BOJ is going to print until it gets to 2% inflation, so until it gets there, I’m going to be short the Yen and short JGBs. I have (and still do) look at the Yen as a one way bet right now. I expect there to be slight pullbacks every now and then and I think the Yen has overshot a bit, but I’m just adding to my positions right now.
29. May 2013 at 10:31
Dtoh,
The timing and all of the numbers depend on qualitative factors that I can’t control and I know nothing about how people will behave in the future and how their expectations will shift. I can’t know exactly how people will behave in the future. All I do know is that Japan’s situation is unsustainable.
29. May 2013 at 11:11
Suvy,
I’m not asking you to predict, just come up with a single disaster outcome scenario which has any kind of reasonable probability. My guess is you won’t be able to. I hear what you’re saying but I just don’t think the numbers ever work out to be that bad unless you make really unrealistic assumptions.
29. May 2013 at 11:46
Dtoh,
With regards to Japan, it’s really hard to say because there is absolutely no historical precedent. We’ve never seen a developed country with such a large debt burden and such a horrible population demography before. Japan, and the entire world, is in a situation where no other country has ever been before. I think it’s going to have some major, major impacts on financial markets everywhere.
30. May 2013 at 05:43
dtoh, It seems to me that you completely ignored my evidence and just went with your gut instinct. Why do booming East Asian countries have lower birth rates than Japan?
I’m not saying you are wrong, I just don’t see the evidence.
30. May 2013 at 18:46
Scott,
I think it’s straight economics. People mostly have kids if it’s a good investment (including of course some utility given to affection given and received). It tends to be a better investment in countries with lower per capita GDP, higher GDP growth, and parents being in a low income percentile within the country.
Specifically, I think the calculus in Japan is a) that child rearing has become expensive food/housing/education (which has nothing to do with GDP growth), b) that with a stagnant economy future income will not grow sufficiently to meet the cost of higher education, and c) that with a poor job market parents will have to support children for a longer period of time after they have finished their education.
7. June 2013 at 10:09
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