John Taylor takes partial credit for the Great Japanese Deflation
Japan’s NGDP has remained relatively flat for nearly 2 decades, while their GDP deflator has fallen at about 1% per year. (Oddly, their CPI is closer to zero inflation.)
What caused this deflation? Obviously tight money. The BOJ could have depreciated the yen if they sincerely wanted inflation. And indeed there were a few periods of slightly easier money, such as 2003-04, and NGDP did rise as a result. But nothing dramatic, and by 2006 they were once again tightening policy again by raising rates and sharply reducing the monetary base. A commenter named “himaginary” sent me an interesting 2010 post by John Taylor, which I had missed. In the post he takes partial credit for forcing the BOJ to tighten monetary policy. This allowed the deflation to resume.
The U.S policy toward the Great Intervention by Japan was part of a strategy to support Japanese efforts to increase money growth to levels achieved before the start of their deflation. So it did relate to quantitative easing. By not registering objections to the intervention, the U.S. made it easier for Japan to increase money growth. The strategy worked this way: When the Bank of Japan intervenes and buys dollars in the currency markets at the instruction of the Finance Ministry, it pays for the dollars with yen. Unless the Bank of Japan offsets””sterilizes””this increase in yen by selling (rather than buying) other assets, such as Japanese government bonds, the Japanese money supply increases. In the past, U.S. Administrations had leaned heavily against the Japanese intervening in the markets to drive down the yen. By adopting a more tolerant position toward the intervention””especially if it went unsterilized””we could help to increase the money supply in Japan. So when Zembei Mizoguchi, the vice Minister at the Japan’s Ministry of Finance, discussed the possibility in late 2002 that currency intervention was going to increase, I did not object, as the U.S. Treasury usually does.
After a few months into 2003, the unprecedented nature of the intervention became clear to everyone. The Japanese would not publicly announce their daily interventions, but the markets began to sense it, and at the end of each month the Japanese would report on the monthly totals. I had arranged for the Japanese to email me personally whenever they intervened in the market, and to call me about very large interventions. When I read email on my Blackberry in the early morning I would frequently find messages from Tokyo like “small intervention during Tokyo trading hours; 1.2 billion dollars purchased,” and I was awakened by quite a few late night or very early morning calls from Tokyo too.
By the summer of 2003, the data began to show that the Japanese economy was finally turning the corner. Though it was too early to be sure about the recovery in Japan, it seemed to me that the Japanese could soon begin to exit from their unusual exchange rate policy of massive intervention. For the next few months we worked with the Japanese on an exit strategy. By early February 2004, the Japanese decided to complete the exit and Zembei called me to outline their exit strategy: They would intervene even more heavily in the next month and then stop. The idea seemed strange to me, but the Japanese had never tried to mislead me, so I knew that this was indeed their strategy.
Intervention did increase and it was not until March 5, 2004 that we really saw the beginning of the end of the intervention. At 8:30 that morning, Washington time, the U.S. Labor Department released their monthly employment report. Employment for the month of February was up by only 21,000 jobs, much less than we or the market had anticipated. News like this would normally have a negative impact on the dollar because weaker jobs data would lower the chances of an interest rate increase by the Fed, thereby making the dollar slightly less attractive to investors seeking higher interest rates. But the dollar did not weaken and on March 5 the Japanese had purchased $11.2 billion dollars that day which made the dollar appreciate rather than depreciate as one would expect. They were not simply smoothing the market, they were working against it. Zembei had told me that they were going to do more intervention before they did less, but this was simply excessive. He was working against market fundamentals. I called him over the weekend to complain that this type of intervention was completely unwarranted and I was as forceful as a friend and ally could be. Zembei acknowledged that they were still intervening heavily now, but the March 5 dollar buy was part of the exit plan. I argued that the exit period had gone on long enough.
Zembei did soon stop intervening, after another week of heavy dollar purchases, but nothing that equaled March 5. The last purchase of dollars occurred on March 16 when the Japanese bought “only” $615 million. On the 17th my Blackberry reported no intervention, and again on the 18th. There was no intervention for the rest of March and the rest of the 2004, and all the way through 2005 and now through September 14, 2010. The yen did not strengthen much in the months after the Great Intervention ended.
What is it about American culture that makes us want to tell Asian countries how to run their economic affairs, but not European countries?
BTW, I realize the BOJ mostly did this on their own and that even without pressure from Taylor they probably would have resumed their deflationary policies. Still, I don’t see the point of us pressuring them. A prosperous Japan is in our interest.
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4. November 2011 at 06:54
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4. November 2011 at 06:56
Slightly off-topic but St. Louis Fed just posted a brief arguing that “monetary policy was accomodative before the crisis when judged in terms of liquidity.”
4. November 2011 at 08:01
“What is it about American culture that makes us want to tell Asian countries how to run their economic affairs, but not European countries?”
FTW
4. November 2011 at 08:58
I am also astonished that Americans seem to think they can intrude or pressure nearly any government in the world to “do something” and that from Afghanistan to Upper Volta, we have to stick our noses in (I know Upper Volta has changed its name, but I like the old name).
Aside from being fantastically expensive ($4 trillion for Iraqistan), all efforts seem to sink back into the more within a few years (even Vietnam, and surely Afghanistan, and probably Iraq).
I hope the Japanese were merely being polite to John Taylor.
4. November 2011 at 09:02
And this goes back decades. From 1980 to early 1985 the dollar appreciated against every imaginable currency. That is, except the yen (zero appreciation). When the dollar depreciated against all major currencies from early 1985 to late 1987, the yen appreciated just as much or even more than the mark.
That “US intervention” on Japan´s economic policy set up the chain of events that ended up throwing Japan inside the “hole” in the early 1990s. From Taylor´s account, the US continued to “intervene” in Japanese economic affairs, bearing (maybe a lot)reponsibility for Japan´s economic fate!(Echoes of WWII?)
4. November 2011 at 09:29
JTapp, Thanks, which is why people shouldn’t pay attention to “liquidity.”
Thanks Brent.
Ben, I also miss the name Upper Volta. I’m glad Congo and Cambodia returned to their original name, and look forward to Burma doing the same. I also wonder why we call Deutschland “Germany.”
Marcus, Agreed, Although at this late date I really can’t believe it’s still just the US. The yen was well over 100 a few years ago, and we didn’t seem to care that much. I think the BOJ is also part of the problem. They didn’t have to let the yen rise all the way to 75. And we tend to make protectionist threats against China, but don’t carry them out.
Off topic, but a student of mine doing a project noticed that the World bank numbers show Canadian M2 rising 120% in 2001. Does anyone know why?
4. November 2011 at 10:15
It’s from the Latin, Germania.
4. November 2011 at 10:29
This puts the lie to Morgan’s view that Taylor would come around with a GOP prez. Why the hell would he be advising the Japanese then?
4. November 2011 at 11:46
The Japaneses “Lost Decades” thing is mostly a myth. Japan’s GDPPC was $19K in 1990 compared with $34K in 2010. In the US, it increased from $23K to $46K. In the US, it doubled and in Japan it increased around 80%, given the sloppiness of GDP statistics, that’s practically within the margin of error. In addition, Japan has shown GDPPC growth at purchasing power parity roughly equal to the other developed countries.
The myth of the lost decades comes from the fact that Japan’s money supply has been much flatter than that of other countries which makes Japan’s growth statistics look worse. Just because the Japanese Central Bank hasn’t been flooding Japan with money, doesn’t mean that the standard of living for Japan hasn’t been improving. It’s been improving at the same rate you’d expect for any other developed country. The fact that they have almost no natural resources and are still managing to keep pace with the rest of the developed world is actually pretty amazing.
4. November 2011 at 12:19
Europe is closer to the American ideal than East Asia. Until recently Europe didn’t have major monetary problems, and isn’t protectionist in the way Japan and Korea are/were. Europe also bought into the American mass imigration model, which is maybe the biggest point of advice Japan gets from economists. Leftwingers hold France as a model (so two thirds(?) of economists have little advice to give them) and rightwingers prefer to rave about socialist Denmark/France/Germany than to give advice.
4. November 2011 at 17:16
For a layman like myself who finds stable NGDP as the best NGDP target with productivity norm deflation as a good thing, why is it bad for the Japanese to be experiencing deflation?
Their unemployment rate throughout this “lost decade” sure seems enviable by US standards and makes Europe look like a depression during their booms.
What am I missing?
5. November 2011 at 14:34
Patrick, Supposed you were introduced to me, and I said–“So your name is Patrick, well I think I’ll call you Sylvester.” How would you feel about that? 🙂
Contemplationist, I think he was carrying out official Treasury department policy (of both administrations.)
John, The real issue is real income, not nominal. That’s much harder to measure. The Japanese unemployment data is quite misleading. I’m not saying things are horrible, but Japan has been hurt somewhat by the deflation.
You said;
“The fact that they have almost no natural resources and are still managing to keep pace with the rest of the developed world is actually pretty amazing”
That fact that they are composed almost entirely of Japanese people, with a Japanese culture, and are much poorer than the US, is rather shocking. Have you seen data on the average income of Japanese Americans?
Japan was recently overtaken by Taiwan, and soon they’ll be passed by Korea.
Justin, I’m not so sure about the protectionism. How come it doesn’t show up in Korean import data? Why did they just sign a free trade agreement with America? Greece had far worse economic policies than either Korea or Japan during the 1980s and 1990s, why didn’t we lecture Greece–try to force them to open their markets?
And then consider that we are giving them BAD ADVICE; deflation, low savings policies, etc, when they’d be better off with mild inflation, and high saving policies.
John, If it was such a good policy, why would the Japanese have run up a massive public debt trying to stimulate the economy, just when Japan should be running surpluses to pay for their demographic time bomb?
The other problem is that the BOJ doesn’t know how to operate in a zero rate environment, so it makes business cycles worse than they need to be. Also, wages are downward sticky, which is why Japan’s natural rate of unemployment (although still low) is much higher than before the deflation.