Should Japan aim for 2% inflation?

The BoJ disappointed investors by failing to offer further stimulus.  The yen soared in value.  No surprise there.  And Japanese stocks fell sharply–no surprise there.  European and American stock futures also fell on the news.  That would be a surprise if you believed the phony hype about “currency wars.”  In fact, macro is not a zero sum game, as I keep emphasizing.  What’s good for Japan is good for the world.  What’s good for Germany is good for the world.  What’s good for China is good for the world.  What’s good for the US is good for the world.  Indeed what’s good for Zimbabwe is good for the world.

So what should the BoJ do?  Is 2% inflation the right number?  (Put aside the fact that they should be targeting NGDP, not inflation.  Let’s say they insist on inflation.)

For the moment, Japan could restore full employment with 1% inflation, perhaps even zero percent (using the GDP deflator.)  That’s because wages are very well behaved.

On the other hand Japan needs an inflation rate that is high enough to keep them away from the zero bound.  Yes, if they had NGDPLT then the zero bound would not be a problem.  But if they inflation target it is a big problem.  So maybe the inflation target should be even higher than 2%.

There is also this ominous warning:

To encourage more investment, the government plans to draw up plans for tax reform by the autumn, when it is due to decide whether the recovery is strong enough to endure the blow to demand from sales tax hikes due in 2014 and 2015.

The tax increases are needed to cope with a growing public debt that already is more than twice the size of Japan’s economy.

While Abe’s “Abenomics” economic policies have helped boost share prices and raised hopes for a sustained recovery, the central bank remains far from its target of achieving 2 percent inflation within the next two years.

I can tell them right now—the recovery is not “strong enough to endure the blow,” and indeed a 5% hike the sales tax would likely cause a recession, unless Japanese inflation rises more rapidly than most people expect.  The new BoJ policy has clearly helped, but Japan is far from being out of the woods.

Japanese stocks have fallen as the yen has recently risen from 103 to 96 to the dollar.  That’s still better than the exchange rate of 80 last year, but 96 is not going to get the job done.  Try 120.

PS.  Unfortunately my first link seems to have changed.



23 Responses to “Should Japan aim for 2% inflation?”

  1. Gravatar of marcus nunes marcus nunes
    11. June 2013 at 12:36

    And yesterday, on hopes of ‘positive actions’ by the BoJ, the stockmarket rose almost 5%!
    Central Bankers have a hard time understanding how the world works, and are always quick to think there job is ‘done’!

  2. Gravatar of Don Geddis Don Geddis
    11. June 2013 at 14:14

    if they had NGDPLT then the zero bound would not be a problem. But if they inflation target it is a big problem.

    That seems to be confusing a target, with a tool. The zero bound is a problem, if they choose to use interest rates as their policy tool. But that ZLB problem with interest rates would happen whether they target NGDP or inflation, wouldn’t it?

    Meanwhile, if they’re willing to do “whatever it takes” (i.e., QE), then doesn’t that solve the ZLB, whether they happen to target NGDP or inflation?

    I don’t see how inflation targeting causes a ZLB threat.

  3. Gravatar of John John
    11. June 2013 at 14:15

    Why did the yield on the Japanese 10 year go up today on the “disappointing” news? You would think that the price of the bonds would rise with “tighter” policies and fall (i.e. yields will rise) with “looser” policies as looser policies should spur higher rates by increasing growth (hence increasing the opportunity cost of sitting in safe assets) and adding an inflation premium to rates.

    I think the short answer is that markets are always puzzling and there’s little point in trying to sort through all the causality.

  4. Gravatar of John John
    11. June 2013 at 14:54


    At some point I’d really like to see some posts on the interaction between nominal and real effects. In much of what I read, including what I read on this blog, it seems that the two are sealed off from each other. For instance, I hear you sometimes say things like the Fed should be in charge of controlling nominal variables while the legislators are responsible for the supply side. Specifically, better policies from the government will lead to more growth and less inflation assuming the Fed hits a 5% NGDP growth trend.

    I think this is a little too easy. History shows many examples were real effects drive nominal effects that are completely outside of the Fed’s control. Events endogenous to the real economy have a massive impact on the monetary system. My favorite example is that the Smoot-Hawley tariff started a trade war that destroyed demand for U.S. farm products. Failure in the farming sector put massive pressure on rural banks who failed in mass partly due to laws preventing the opening of multiple branches.

    In this scenario, two laws, the Smoot-Hawley tariff and banking regulations, had a massive impact on the supply of money (higher aggregates like M2 contracted rapidly due to the pyramiding on top of the base) and the demand to hold cash (or velocity of money) due to a flight into cash or gold for safety.

    Even if the Fed had acted heroically as a lender of last resort (they did make unprecedented interest rate cuts at the NY fed), it is unclear that they would have been able to offset these shocks given the fact that they couldn’t create money out of thin air like they can today.

    We see the same phenomenon today with the explosion of excess reserves. Real events make the Fed seem impotent. Today they are constrained by “conventional wisdom” instead of the gold standard, but that doesn’t really make a difference.

    I get that in either case the Fed could do more but the artificial constraints of their day and ours are stronger than anyone might have thought.

  5. Gravatar of reader223 reader223
    11. June 2013 at 15:49

    Don, I think you’re right. Nick Rowe did a post about this about 9 months ago. Here’s the link:

  6. Gravatar of dtoh dtoh
    11. June 2013 at 16:11

    Until people understand clearly how monetary policy works, there will be ongoing confusion.

    There are two stimulative effects.

    1. An increase in the real price (1/expected real risk adjusted return) of financial assets.

    2. An increase in expected NGDP.

    Both of these cause an increase in spending on real goods and services (i.e. they boost NGDP).

    The confusion arises because:

    3. A failure to distinguish between nominal prices and real prices of fixed income financial assets. (e.g. thinking that because nominal bond yields have gone up that the real price of financial assets has gone done.) If inflation expectations have increased from 0 to 2% and nominal yields have increased by a mere 50 bp than real yields have dropped (and real prices have spiked) significantly. So even though nominal yields are up, the decrease in real yields (i.e. increase in real price) can be highly stimulative.

    4. Failure to understand that the stimulative effect of expected higher NGDP can result in lower real prices of financial assets (e.g. higher real yields on bonds) while at the same counteracting and even overwhelming the contractionary effect of those lower prices. (As Scott always points out higher real interest rates are a sign of successful monetary policy).

    5. The mistake of targeting interest rates or inflation (and even bigger mistake of targeting nominal interest rates) makes it much more difficult for the market to interpret CB action and makes it much more difficult for the CB to set policy or determine the effectiveness of its policy.

    A few additional comments.

    Re-starting the Japanese TIPS market would provide useful information on expected inflation.

    Someone with some free time could probably use the movement in nominal equity prices to estimate changes in expected NGDP by looking at the correlation between corporate earnings and NGDP growth.

  7. Gravatar of Don Geddis Don Geddis
    11. June 2013 at 19:24

    @John: You seem to understand all the tradeoffs. I can’t figure out what your question is, though. Smoot-Hawley isn’t really relevant, because that wasn’t a fiat money regime. As for the rest, you say “assuming the Fed hits a 5% NGDP growth trend“, so it appears you’re asking about what is possible, about how nominal and real quantities interact in theory. But then you also say: “the Fed seem impotent…they are constrained by “conventional wisdom”“. That’s an observation about the current real world. I don’t think anyone would argue against the Zero Lower Bound having had an obvious real effect. Sumner is trying to change this conventional wisdom. He’s saying: look at the theory. The ZLB isn’t a real barrier; it’s all in your minds. The Great Recession has been a self-inflicted wound that could have been avoided simply by making different choices.

    Is your question, why did the central bankers make the choices they made? The answer to that is political and sociological. Sumner (mainly) addresses the question of what is possible, given our knowledge of macroeconomics. If central bankers (and academic economists, and the public) were better educated about these topics, then we could all make different choices, and avoid the completely gratuitous economic damage of the last few years.

  8. Gravatar of Benjamin Cole Benjamin Cole
    11. June 2013 at 19:59

    Excellent blogging, per usual.

    I ask again, when did a 2 percent ceiling become sacred?

    Are there any studies to suggest real growth is higher at 2 percent than at 3 percent?

    The experiences of 2008, and the Japan experience, suggest to me there is danger is such low rates of inflation. If a central bank has a 2 percent ceiling, and you hit a bad recession…

    Then the central bank must go to QE, hot and heavy. But that is “unconventional” policy, so you get dithering, and uncertainty, and feeble amounts of QE etc. And hysterics.

    You know, when the Fed started QE, some sweat-drenched pundits screamed the Fed would not be able to keep inflation in single digits.

    They were right!

    We are now below single digits, at 0.7 percent y-o-y on the PCE.

    With QE, the Fed has been unable to keep inflation in the singled-digit range. It is lower than that.

    There is a real question out there: In the modern, capital-glutted world, when Economy Grandma slips on the ZLB ice, how long does it take to get her back up?

    I am thinking it takes years and years of QE, as in seven or 10, or maybe even a permanent program….

    Of course, if we ran inflation a little higher, in the 3 percent to 4 percent range, then resort to QE might not be necessary…

    Yes, I prefer NGDP targeting too, but….we MM’ers are alone on that.

  9. Gravatar of dtoh dtoh
    11. June 2013 at 22:13

    Benjamin Cole,

    You ask;

    “In the modern, capital-glutted world, when Economy Grandma slips on the ZLB ice, how long does it take to get her back up?”

    1. Everybody needs to stop talking about the mythical ZLB. It only exists if you subscribe to HPE as the transmission mechanism. In that worldview, when money gets transformed from a medium of exchange into a store of value then poof no more HPE. If you correctly understand that OMP works through a) NGDP expectations and b) the real price of financial assets then the ZLB is meaningless (i.e. the fact that money has become a store of value/financial asset doesn’t matter). The only ZLB is the limit on how high inflation expectations can go.

    2. But in answer to your question, since AD growth at the margin is driven not only by financial asset prices but also by NGDP expectations, most CBs are playing with both hands tied behind their back because they won’t communicate an explicit NGDPLT.

  10. Gravatar of Max Max
    12. June 2013 at 03:31

    Don, “Meanwhile, if they’re willing to do “whatever it takes” (i.e., QE), then doesn’t that solve the ZLB, whether they happen to target NGDP or inflation?”

    As Nick Rowe put it recently, QE is _conventional_ monetary policy. The only special “power” it has is that it allows CBs to communicate dovishness without using the politically incorrect “i” word.

  11. Gravatar of ssumner ssumner
    12. June 2013 at 04:04

    Marcus, That’s good.

    Don, Those are good points, but with NGDPLT it’s much easier for the central bank to keep close to the target path. More importantly, a persistent policy failure is much less costly. If you undershoot your NGDP target by 2% for 5 years in a row, you’ve undershot by a total of 2%. If you undershoot your inflation target by 2% for 5 years in a row, you’ve undershot by a total of 10%. Which is much worse.

    John, I have a book coming out later this year that is full of discussion of real and nominal interactions during the Depression. Keep in mind that monetary ineffectiveness arguments that apply under the gold standard, do not apply under a fiat money regime.

    dtoh, Good points.

    Ben, But the NGDP targeting world is gradually expanding beyond MMs.

  12. Gravatar of John John
    12. June 2013 at 05:21

    Don Geddis,

    I was hoping that Sumner would talk about how non-monetary events can affect monetary aggregates. I get the point that he is trying to change the perception of what the Fed can accomplish in any type of environment but I’d also like to hear about the challenges the central banks face. It seems worthwhile to analyze why central banks become so ineffective at 0. Also, I don’t think they are entirely to blame for a monetary contraction.

    Eugene Fama, the creator of the EMH, likes to argue that the Fed doesn’t actually control interest rates and that the market really sets interest rates and the money supply and the Fed just follows along. For instance, he argued that private demand to hold currency (outside of the Fed’s control) caused the money collapse of ’31-’33. Given how much Scott’s views have in common with Fama’s (especially regarding the “housing bubble”) it is surprising that they would hold such different views on money.

    Btw, here’s an interesting interview with Fama where he shares some unusual views. For instance, a recession made people unable to pay their mortgages which led to a collapse across all asset markets not just housing.

  13. Gravatar of John John
    12. June 2013 at 05:31


    You said, “Keep in mind that monetary ineffectiveness arguments that apply under the gold standard, do not apply under a fiat money regime.”

    Obviously that’s technically correct. However, I think there are worse constraints with the PhD standard than the gold standard. Under a PhD standard, the central bank will basically carry out the mean of economist’s (and the public’s) current opinions on appropriate action at any given time. Economics being a somewhat faddish profession, this poses problems. For instance in the 1960s and 70s, the profession was focused on full-employment at any cost and ignored the quantity theory of money. Today they are wedded to ideas about interest rate targeting and are constrained by their fear of losing face by changing policy.

    The real problem with the gold standard, and it’s fatal flaw, was that it wasn’t binding enough. The PhDs got it into their head that they could create better results by mixing discretionary policy with the gold standard. While that may have been true in theory, it was irrelevant in the real world which is full of frictions. It isn’t a coincidence that the Depression happened right as economist and politicians were becoming confident that they could fine-tune the economy.

  14. Gravatar of John John
    12. June 2013 at 05:34

    Ben Cole,

    It wouldn’t take so much QE if Economy Grandma (the Fed) would avoid falling down in the first place by looking at the conditions in front of her rather than behind her.

  15. Gravatar of Abitnomics Abitnomics
    12. June 2013 at 08:13

    Money printing and dilution of paper currency would only result in headaches for majority of citizens who earn fixed salaries. Seldom or often not, salary workers will ever get the pay rise needed to offset the inflation.

    Who says that a cheaper yen will encourage exports? Whenever inflation due to currency devaluation happens, exporters (including the Japanese) will adjust their prices to curb the losses incurred. Assuming say yesterday the exchange between JPY to USD is Y100:US$1.50 with, tomorrow the rate drops to Y100: US$1.20, the Japanese merchants will raise their pricing of goods by Y30 instead to absorb losses?

    Speaking of which merchants/business owners and governments still maintain their profits. The biggest losers will be the fixed income earners or the wage earners.

    When Japan said that they have been experiencing stagflation and deflation for years now, it translates to their own government voicing that they want more income now from the public. By printing more notes and inducing inflation, they get to impose a hidden form of tax upon their own citizens realizing their goals.

  16. Gravatar of ssumner ssumner
    12. June 2013 at 09:01

    John, You make some good points, but none of this is carved in stone. The purpose of my blog is to change the Fed’s policy regime. They’ve learned from past mistakes in the past, and they can learn again.

    I was arguing that real shocks don’t affect NGDP with sound monetary policy, but I agree they can do so with unsound monetary policy. recall i argue that fiscal multipliers are nothing more than estimates of central bank incompetence.

  17. Gravatar of Rien Huizer Rien Huizer
    13. June 2013 at 00:45


    In a comment on an earlier Japan post, I suggested that Japanese politicians saw opportunistic benefit in MM, especially the exchange rate effect. Once the FX competitiveness was restored, there might be other (political) priorities -plus: upward pressure on wages is the last thing their target audience would want.

    Since the key effect of MM is to stabilize NDGP along a feasible (demographics, technology) upward sloping path. That requires a long time horizon and very strong CB credibility, it appears that what the Jap. gvt has done is using the symbols of MM to do something completely at odds with that: short time horizon and deliberate undermining of CB credibility (loss of independence, indiscretion of officials.

    That seems to me to illustrate the main weakness of MM (throught succesful NGDPL targeting) as a practical approach: in order to get the efficiency benefits of it (MM should result in much less financial market volatility and greater certainty around nominal investment decisions, hence lower risk premia for all kinds of real options, including employment) MM must be credible over a very long time horizon. That would antagonize two sets of powerful actors: politicians (who like to buy votes under the guise of fiscal stimulus) and markets people, who thrive on changing expectations and risk aversion of the public.
    How does one incentivize politicians to adopt MM, in other ways than the imo rather cynical (but clearly with the LDP tradition) use of MM tools in an unsystematic fashion. Maybe mr Svensson has an aster to that..

  18. Gravatar of Apenomics Apenomics
    13. June 2013 at 06:09

    Do economists and all of you agree that prices are sticky?
    You can’t increase the prices of consumer goods and make shops lower them just by manipulating your currency exchange rates for economic growth. It’s pretty much a 1 way ticket and all the way to oblivion.

    Governments are stealing our money’s worth using the idea of inflation.

    A video demonstrating how inflation is a tax to steal your money in your banks:

    Where did Shinzo Ape got his education?
    Some elite school? Well, that’s sums it all and explain why he’s among the same cronies along with Paul K and Helicopter Bernanke.

    Further down the road, the effects are even more disastrous in a long run.

    1) Inflation causes your citizens to buy less and less until one day they can no longer afford to have households.

    2) More jobs are going to go because of less spending.

    3) Population growth(*now this is serious consideration). Expensive countries will discourage family development and discourage many youths from getting married.

    4) As a result from point 3, economies will have to start considering immigration options for importing foreign labors. This will change the face of a country’s demographics and possibly infiltration/invasion into any country.

  19. Gravatar of ssumner ssumner
    13. June 2013 at 08:02

    Rien, Your entire comment is based on a misconception–the BoJ has given no indication they are adopting NGDPLT. Instead, they are adopting the same policy as the US and ECB have, a 2% inflation target.

    I don’t believe that NGDP targeting needs long term credibility to be effective, although it helps.

    In any case, even if you were right it would not be an argument against NGDP targeting, as all other targets have the same problems.

    Apenomics, I have no idea what you are talking about. The goal is not to reduce shop prices.

  20. Gravatar of Apenomics Apenomics
    13. June 2013 at 09:42

    ssumner, You mean inflation has no relation to shop prices?

    Japanese people still hold the same buying power as before with the devaluation of their Yen currency?

    If I’ve a billion yen in my retirement savings account since June 2012, am I richer now than I was? Do I need to trim down my shopping list for the upcoming US Christmas trip?

    I am still in dilemma whether I’ve gotten poorer than I used to. Maybe I deserve a wise explanation from Shinzo Ape himself.

    Does the greed of man for more money blinds them from noticing its declining value? I’m just a wage earner, my fixed salary doesn’t par with inflation and adjust itself according to inflation and deflation.

    Only exporters and governments have that privilege to adjust their prices or trade with their currencies of choice to avoid losses. Even if they adjust higher Yen prices, Americans or others who have their currencies appreciated against the Yen won’t feel a pinch because they’re still paying the same prices as before the yen declined.

    Do you get it?

  21. Gravatar of Rien Huizer Rien Huizer
    13. June 2013 at 12:57

    Scott, I do not agree at all. The Japanese case did have the look and feel of a market monetarist approach to boost AD, and with FX effects as a desirable additional channel. Imo the FX effect was the only thing Abe’s backers wanted and now that is achieved we go back to our daily routine. There isn’t a politician in Japan who cares about the economy as we may see it.

    I am not at all against NDGP targeting, and I guess any smart stationary authoritarian would prefer this to other CB policies. But democracies are different, politicians have needs and free financial markets are operated by people who do not mind the occasional overshoot, as long as the client pays. So yes, I think I discovered another reason why NGDPLT is economically attractive, but politically problematic; an entrenched, partially hereditary and systematically corrupt political class, plus a people who have gotten used to be governed that way as long as pork is provided. Japan is not alone in that respect..

  22. Gravatar of ssumner ssumner
    14. June 2013 at 08:51

    Rien, That suggests we should not rely on “look and feel” but rather hard logic.

    I think your basic approach to politics is so nihilist that if you are right then the world would be better off destroyed by an asteroid. There’s no point in even discussing policy if corruption always trumps idealism.

    I happen to believe Japanese politicians do care about the economy, partly because they want to be re-elected.

  23. Gravatar of Rien Huizer Rien Huizer
    15. June 2013 at 03:28


    Sorry to drag this on but I of course my view of politics (a mainstream academic view, not really nihilistic) does not imply we would be better off..etc. :
    1. politicians may be in a situation they have to care about elections and hence care about the economy (apart from the fact that there are various schools of economic thought). That depends on institutions. The Japanese system has a lot of inertia, and traditionally what counts is how power and policy combine to gain factional dominance. It takes a rare combination of events to break that pattern, the LDP is solidly back and hence I think “pandering to voters” will be limited to rhetoric for the time being. So whether these politicians are altruistic (and in what way) or rational/self interested within a system that requires offering good policy to the median voter, politicians might care about the economy, in excess of their private interests, in Japan they are not under pressure now to offer good policy and they are from a tradition that sacrifices welfare as we tend to see it (relative to most Anglo countries) in favour of international competitiveness, without voters voting them out.
    2. I clearly believe that a system where politicians act out of self interest is worth living in, provided there are institutional safeguards for maintaining a healthy level of competition. And that is difficult because of the influence politicians as a group have over institutions. Washington is on the one hand, a highly desirable market for influence (the engine of democracy) and on the other, maybe increasingly, a club of insiders, similar to the LDP. Faux-grassroots phenomena like the Tea Party appear to have no impact on the institutional patterns, just raise the price of political services. I am more hopeful that a high level of social mobility and technological change, will prevent institutional sclerosis, where indeed, the political self interest becomes seriously harmful. Categories like corruption and idealism are problematic and socially contingent.

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