The new Bank of Japan chief Haruhiko Kuroda today unveiled an aggressive new round of monetary easing, the latest step in the policy of recently-elected Japanese Prime Minister Shinzo Abe.
As part of a promise to do “whatever it takes” to return Japan to growth, Kuroda promised a level of quantitative easing unseen before in Japan, intended to discourage saving and encourage spending. Kuroda promised to print 50 trillion yen ($520bn; £350bn) per year.That is the equivalent of almost 10% of Japan’s annual gross domestic product, and over double the level of what the Federal Reserve is currently experimenting with.
Many are hailing this as an attempt to put into practice the advice of Ben Bernanke to Japan in the 1990s — what Bernanke called “Rooseveltian resolve“. In fact, Ben Bernanke has provided a practical as well as a theoretical template through the unconventional policies adopted in the last five years by the Federal Reserve. Although some economic commentators believe that Shinzo Abe was more interested in reviving Japanese mercantilism and drive exports through a cheap currency, it is fairly clear that even if that is Abe’s ultimate intent, Abe is certainly harnessing Bernankean monetary policies (as well as Keynesian fiscal stimulus policies) in that pursuit.
So, will Abe’s policies return Japan to growth, as Bernanke might have intended?
Well, this diagnostic pathway sees deflation as the great central ill. The rising value of a currency acts as a disincentive to economic action and the encouragement of hoarding, because economic participants may tend to offset projects and purchases to get a greater bang for their buck. (This, of course, would be the great problem with Bitcoin becoming the sole currency as its inherent deflationary nature encourages inactivity and not activity, but that is a topic for another day). During deflation, delayed projects and subdued consumer spending are reflected in weak or nonexistent growth. More expected inflation encourages businesses and individuals to consume and start projects rather than save. At least, that’s the theory.
In theory, there’s no difference between theory and practice. In practice, there is. So in practice, what other effects are at play here?
First of all, the Japanese in general (or a substantial and influential proportion of them) seem to really dislike inflation. Why? Well, since the initial housing and stocks bubble burst in the 1990s, they have become a nation of capital accumulators with a low private debt level. This is at least partially a demographic phenomenon. Older people tend to have a much higher net worth than younger people who have had less time to amass capital, and they need places to park it — places like government and corporate debt. This has driven Japanese interest rates to the lowest in the world:
The other side of the coin here is that this has made it very easy, almost inevitable, for the government to run massive budget deficits and run up huge levels of debt (which has to be rolled). Higher inflation would mean that those elderly creditors (who have up until now voted-in politicians who have kept the deflationary status quo) will very likely experience a negative real interest rate. Many may find this a painful experience, having grown used to deflation (which ensures a positive real interest rate even at a very low nominal interest rate, as has been the case in Japan since the 1990s):
Every time Japan’s real interest rate has touched zero, it has shot back up. Japan has an aversion to negative real interest rates, it seems. And this is in stark contrast to countries like the UK and USA which have experienced much lower real interest rates since the 2008 crisis. A negative real interest rate in Japan would be a shock to the system, and a huge change for Japan’s capital-rich elderly who have happily ridden out the deflationary years in Japanese government bonds. (Of course, if reversing deflation revived real GDP growth then they would have more places to park their capital — like lending to or purchasing equity in growing business — but the question is whether or not the Japanese people at large have an appetite for such a shift).
Another challenge to growth is the existence of Japan’s zombie corporations and banks — inefficient, uncompetitive entities kept alive by government subsidies. Although some zombie banks left on life-support from the 1990s were terminated during the Koizumi years, it is fairly clear from total factor productivity figures of both Japanese manufacturing productivity and non-manufacturing productivity are still very uncompetitive. How can a burst of spending as a result of inflation turn that around? Without removing the subsidies — something that Abe, as a leader of the establishment Liberal Democratic Party, the party that has ruled Japan for the overwhelming majority of the postwar years, and is deeply interwoven with the crony industries is very unlikely to do — it may prove very difficult to return Japan to growth. And of course, these industries own the bulk of Japanese debt, so attempts to reduce the real interest rate is likely to prove deeply unpopular with them, too. (On the other hand, Japanese banks will profit from these open-market operations through flipping bonds at a profit, so the new policies may have their supporters as well as opposers among Japan’s zombie financiers).
This doesn’t necessarily mean that the Bank of Japan’s new programs are doomed to fail, or that they are likely to trigger severely adverse outcomes, but if serious attempts are not made to tackle the systemic challenges and entrenched interests, then it is hard to see how much can come out of this other than a transitory inflationary and devaluationary blip followed by a retreat to more of what Japan has become used to, and what much of Japanese society seems to like — low growth, a strong yen, and low inflation or deflation. And if Abe’s gameplan is really to grow by boosting the exports of the crony industries, then hope of desubsidisation of the crony industries seems almost entirely lost.
Certainly, more fiscal stimulus will eat up slack capital resources. And certainly, this is an interesting experiment on the fringes of Monetarism and monetary policy in general. If Japan goes through with this experiment, hits its inflation target and triggers sustained nominal GDP growth this will be a decent empirical test of whether or not such policies can lead to sustained real GDP growth. But there is no guarantee that Japan has the Rooseveltian resolve to follow through with these policies, and even if it does there is no guarantee that they will lead to a significantly higher trend in real GDP growth. The underlying system is deeply entrenched.