Japan is coasting on its success

A few months back I argued that Japan’s recent policy moves were effective, but not enough to reach their 2% inflation/3% NGDP growth targets.  I still believe that to be the case.  First the positives:

1.  The yen is down to around 97/$, well below the 79/$ level of mid-November 2012, when rumors of Abenomics first hit the market.

2.  RGDP growth was 4.1% in Q1 and 2.6% in Q2.  Unfortunately I don’t have NGDP numbers, but I’d guess they are positive.  (Trend NGDP growth in Japan is zero, so positive is good.

3.  Inflation rates are slowly increasing. (Actually deflation is ebbing)

4.  Unemployment is falling, down to 3.9% in July.

Now the negatives:

1.  Inflation still seems unlikely to hit 2%.

2.  The yen has been appreciating since it fell to 103/$ a few weeks back

3.  Q2 RGDP growth was below the 3.6% expectation.

4.  Japan will be hit by an adverse supply shock next year (higher sales tax rates) which will boost inflation–making it look like they will hit their 2% target.  Don’t be fooled.  When the effects wear off Japanese inflation will slip back below 2%. Because of Japan’s fiscal situation, it has no good options.  The sales tax increase will hurt the economy, but is needed.  I used to think they should delay it, but now I think they should bite the bullet and do it.

They got off to a good start, but need to do more.  I suggest another round of yen depreciation combined with more QE.  What they did helped a little – – – so do more!

 

 


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24 Responses to “Japan is coasting on its success”

  1. Gravatar of Yaron Yaron
    12. August 2013 at 10:21

    I do not understand why it is so necessary to have higher sales tax rates in Japan. What will happen if they don’t increase the tax rate? no one will buy the government bonds? hyperinflation? It is absurd to try to flood the economy with money on the one hand and then to take money from the consumers on the other hand.

  2. Gravatar of ssumner ssumner
    12. August 2013 at 10:29

    Yaron, Eventual bankruptcy and hyperinflation?

  3. Gravatar of Chun Chun
    12. August 2013 at 10:33

    Dr. Sumner,
    If the proposed sales tax hike fails(?) to raise price level by 2% but raises it higher than the current level while gaining no RGDP growth, will the BOJ have to conduct more aggressive purchase policy?

  4. Gravatar of Your Neighbourhood Economist Your Neighbourhood Economist
    12. August 2013 at 10:36

    I am not sure whether more QE is the answer. It has had an effect in terms of reducing the value of the yen but this will only take of pressure off the government and would likely stymie any chance that some of the reforms the government has promised will be implemented. For more on this, see http://yourneighbourhoodeconomist.blogspot.co.uk/2013/06/all-bets-are-on.html

  5. Gravatar of Yaron Yaron
    12. August 2013 at 10:38

    On the one hand, trying desperately and unsuccesfully to stop deflation and have 2% inflation. On the other hand, taking dramatic and painful steps to prevent future hyperinflation? Something does not make sense. Maybe they should have 2% inflation first and then start worrying about hyperinflation.

  6. Gravatar of TravisV TravisV
    12. August 2013 at 10:41

    Prof. Sumner,

    More proof that on monetary policy, elite Democrats > elite Republicans, courtesy of Elizabeth Warren and Bernie Sanders:

    http://www.huffingtonpost.com/rep-bernie-sanders/four-questions-for-fed-ch_b_3740369.html

    “Question 1: Do you believe that the Fed’s top priority should be to fulfill its full employment mandate?

    ………

    Question 4: What would you do to divert the $2 trillion in excess reserves that financial institutions have parked at the Fed into more productive purposes, such as helping small- and medium-sized businesses create jobs?”

  7. Gravatar of Rafael Barbieri (@RafaelBarbieri9) Rafael Barbieri (@RafaelBarbieri9)
    12. August 2013 at 10:45

    “Japan will be hit by an adverse supply shock next year (higher sales tax rates) which will boost inflation-making it look like they will hit their 2% target.”

    How will this not be a demand shock? How is this a supply shock when the tax on consumption does not directly impair the productive capacity of the real economy? I would think a sales tax would reduce demand putting downward pressure on inflation. A sales tax is a tax on consumption, right?

    “When the effects wear off Japanese inflation will slip back below 2%.”

    “Yaron, Eventual bankruptcy and hyperinflation?”

    Wow that escalated quickly. Japan goes from fighting off deflation to “bankruptcy” via hyperinflation (eventually) possibly if a sales tax isn’t administered eventually.

    That escalated quickly!

    http://www.youtube.com/watch?v=2z0POMQQ6oY

  8. Gravatar of Rafael Barbieri (@RafaelBarbieri9) Rafael Barbieri (@RafaelBarbieri9)
    12. August 2013 at 10:49

    I agree with Yaron.

    “Maybe they should have 2% inflation first and then start worrying about hyperinflation.”

    Maybe they should HIT a 2% inflation target first before worrying about hyperinflation scenarios! Hopefully they do so in a way where the change in nominal wages are greater than the positive change in the price level that way Japanese households aren’t squeezed.

  9. Gravatar of ssumner ssumner
    12. August 2013 at 11:04

    Chun, They certainly should do so.

    Your, They should do both. I don’t believe in whipping the unemployed until the leaders feel so much pain they need to reform. It’s the unemployed that are whipped, not the leaders.

    Yaron, Printing a bit of money isn’t desperation. Wait until we get to 300 yen to ths dollar. If still no inflation then it’s time to get desperate.

    Travis, Is that the Elizabeth Warren who supports Volcker for Fed President? There’s not much difference between the parties, just a difference as to who is in office right now.

    Rafael, If unions negotiate much higher wages that’s an adverse supply shock, and so is higher sales taxes. Neither affect capacity. It’s a SRAS shock , not an LRAS shock. It will tend to raise prices and reduce output, which is practically the definition of a supply shock.

    Regarding your second point—do both! Raise inflation and raise taxes.

  10. Gravatar of TravisV TravisV
    12. August 2013 at 11:18

    Prof. Sumner,

    I think you’re wrong. Imagine if we had President Romney right now and he nominated Greg Mankiw to chair the Fed. You simply wouldn’t see the same fire-breathing opposition from congressional Democrats.

  11. Gravatar of Rafael Barbieri (@RafaelBarbieri9) Rafael Barbieri (@RafaelBarbieri9)
    12. August 2013 at 11:26

    “Rafael, If unions negotiate much higher wages that’s an adverse supply shock, and so is higher sales taxes. Neither affect capacity. It’s a SRAS shock , not an LRAS shock. It will tend to raise prices and reduce output, which is practically the definition of a supply shock.

    Regarding your second point””do both! Raise inflation and raise taxes.”

    The sales tax itself is still a demand shock. If unions or any wage earner are able to successfully negotiate higher wages, and IF corporations/businesses are able to successfully respond by passing the entirety of the increase in labor cost onto the consumer, then prices will rise while output declines.

    If wager earners are unsuccessful, then the tax will reduce demand which will put downward pressure on prices.

    If the wage earner is successful, but the corporation is not able to pass on the cost in the form of higher prices, then the corporate revenues and profit margins will adjust downward. If the corporations responds by laying off workers, the increased wages won by some wage earners will be partially offset by a loss of income by the newly unemployed.

    Therefore, the sales tax itself though (first thing that happens in the possible chain of actions) is still a demand shock, but I can absolutely see your point that wage increases (for whatever reason) are SRAS. However, if the corporation does not respond to lower profitability by laying people off, and if those that successfully negotiated increased wages increase their spending, aggregate demand will increase.

    How this all nets out still remains to be seen considering everything after the initial tax would be uncertain as the actions would depend on behavior.

    Also, I greatly appreciate that you took the time to respond.

  12. Gravatar of John Hall John Hall
    12. August 2013 at 11:39

    I get slightly different Japanese data. 3.8% to 2.6% RGDP for Q1 and Q2, while 2.5% to 2.9% NGDP growth over the same periods. I can’t seem to find GDP deflator that would be consistent with both of these sets of data, but you could get an implied GDP deflator that fell -1.2% and then grew 0.3%.

  13. Gravatar of Rafael Barbieri (@RafaelBarbieri9) Rafael Barbieri (@RafaelBarbieri9)
    12. August 2013 at 11:45

    Also, if the above are potential scenarios that occur after the tax, someone in all scenarios is made worse off. So, why even consider the tax? Either output declines, corporate profitability declines, wages decline (either uniformly or only on the newly unemployed). The sales tax in itself could prove futile. Sure the tax on each marginal purchase (unit) is increased, but if aggregate sales decline, the aggregate sales tax revenue could be lower.

    I could understand if productive capacity was bumping up to its limit where it was desirable to reduce consumption, wages, corporate profitability, and/or output. Is that really the case?

  14. Gravatar of Bren Bren
    12. August 2013 at 13:35

    Ive got the same numbers as John Hall, but GDP deflator at -1.3% and 0.4% in Q1 and Q2 respectively.

  15. Gravatar of chris mahoney chris mahoney
    12. August 2013 at 15:41

    They should have followed McKinnon’s advice a decade ago and re-pegged to the dollar. They are incapable of intelligent policy.

  16. Gravatar of chris mahoney chris mahoney
    12. August 2013 at 15:52

    A political observation: in Japan, the Mandarins are much more powerful than the regime du jour. The bureaucracy controls the government, as it has since 1868. Japanese democracy is a sham. The Cabinet Office has a lot of levers that are connected to nothing. The PM is allowed to give speeches, not orders. The MacArthur Constitution changed nothing with respect to actual governance, aside from removing whatever slight power the monarch ever had. For starters, the BoJ independence law, which has been an unmitigated disaster, must be repealed. But al that will do is restore the MoF’s power over the BoJ. The government has little power over the MoF. This explains why, in such a serious country, the politicians are clowns.

  17. Gravatar of Declan Declan
    12. August 2013 at 17:13

    Here is the latest Japanese GDP data – real and nominal: http://www.esri.cao.go.jp/en/sna/data/sokuhou/files/2013/qe132/gdemenuea.html (scroll down for links to spreadsheets)

    Here are the quarterly growth rates for (seasonally adjusted) nominal GDP for the last 6 quarters:

    2012/
    1- 3. 1.2
    4- 6. -0.8
    7- 9. -0.9
    10-12. 0.1
    2013/
    1- 3. 0.6
    4- 6. 0.7

    A lot of the numbers thrown around (like 4.1 and 2.6%) are ‘annualised’ i.e. they are hypotheticals based on a given quarter’s growth rate continuing for a whole year. The (seasonally adjusted) real growth rates were 0.6% this quarter and 0.9% last quarter.

  18. Gravatar of Declan Declan
    12. August 2013 at 17:18

    If you scroll down further they have deflators as well.

  19. Gravatar of ssumner ssumner
    13. August 2013 at 04:50

    Travis, The point is that Romney or any other GOP president would pick someone like Mankiw, who is very similar to the guy Obama picked.

    Rafael, I’d suggest getting rid of your “If” statements and use marginal analysis. It’s much simpler. A sales tax raises prices and reduces output. That a supply shock.

    On your second point, you raise taxes to avoid hyperinflation or bankruptcy. And you don’t wait until the last minute. Even Krugman supported tax increases this year, and he’s famous for not worrying about the deficit.

    John, Maybe Q1 was revised.

    Chris, Actually, if you believe the Japanese equity markets, Abe is much more powerful than western leaders, especially eurozone leaders.

    Declan, Thanks. All US data is annualized, which is why many of my commenters naturally think in those terms.

  20. Gravatar of Rafael Barbieri (@RafaelBarbieri9) Rafael Barbieri (@RafaelBarbieri9)
    13. August 2013 at 08:00

    Thanks Professor. I still have much to learn and will incorporate your suggestion.

    “On your second point, you raise taxes to avoid hyperinflation or bankruptcy. And you don’t wait until the last minute. Even Krugman supported tax increases this year, and he’s famous for not worrying about the deficit.”

    I think what is lacking is a plausible scenario where a monetary sovereign can go from fighting deflation to hyperinflation/bankruptcy. That way one would be able to evaluate whether or not the policy is appropriate right now given that deflation and lack of spending is the issue.

    It will be interesting to see how this plays out when the consumption tax is passed. At that point we might be able to better understand whether this analysis is correct. Until that point, I guess it is wait and see.

  21. Gravatar of Rafael Barbieri (@RafaelBarbieri9) Rafael Barbieri (@RafaelBarbieri9)
    13. August 2013 at 08:06

    Also,

    “A sales tax raises prices and reduces output. That a supply shock.”

    I think the confuse lies in what one defines as a short term supply shock. If you want to broadly define it as output being reduced while prices rise, than I can see how the tax will most likely cause this temporarily.

    However, I use the strict definition that a supply shock is anything that affects the real productive capacity of the economy, positively or negatively. Since the tax does not impact the real productive capacity, under this definition it is a demand shock. Yes, output declines, but Japan’s ability to produce that real output has not.

  22. Gravatar of Saturos Saturos
    13. August 2013 at 21:50

    The BoJ needs to do whatever they can in order to hit their own mandate, and keep to it. And then they should stop, and the government should focus on other things.

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