August 2023 Monthly: Don't wait for the Bank of Japan to raise interest rates!

 

August 2023 Monthly:

Don't wait for the Bank of Japan to raise interest rates!

 

August 21, 2023

 

 

(1) Japan's GDP for the April-June quarter of 2011 is red flag of overheating! The real annual rate of 6% compared to the previous quarter and the nominal annual rate of 12% allow for an overshoot beyond the Heisei bubble period!

 

The Nikkei Shimbun said, ``The preliminary figures for gross domestic product (GDP) for the April-June quarter of 2023 announced by the Cabinet Office on the 15th increased by 6.0% on a seasonally adjusted annualized basis compared to the previous quarter. This was the third consecutive quarter of positive growth, greatly exceeding the previous forecast.”

 

However, there is a saying, "Too much is too little." For example, during the height of the Heisei bubble in 1990, the real GDP growth rate was +5.6% and the nominal GDP growth rate was +8.4%. Both in real terms and in nominal terms, they have considerably exceeded those during the Heisei bubble period.

 

On the other hand, the deflator increased by 3.4% year-on-year in the April-June quarter of 2011, but it also increased by 1.4% compared to the previous quarter. Equivalent to 10% price increase.

 

The overshoot of the GDP growth rate, which surpassed that of the bubble period, is due to the unusual monetary easing that has continued for more than 10 years, and has clearly allowed high inflation, a sharp depreciation of the yen, and soaring real estate prices. , has caused a large imbalance in the economy, and we cannot help but see that the Japanese economy is out of control if the monetary easing of a different dimension is continued.

 

A typical example of an imbalance is a one-shot engine that only contributes to net exports while domestic demand such as personal consumption and corporate capital investment continues to contract as a result of high inflation and a significant depreciation of the yen amid the continuation of monetary easing of a different dimension. I have to say that the distorted high economic growth that seems to fly by itself is clearly manifested.

 

This increase in net exports was due to an increase in exports of automobiles and other goods against the backdrop of the weaker yen, as well as the effect of inbound consumption by foreign tourists, which was also brought about by the weaker yen. Ironically, the decline in imports led to an increase in net exports, as imports fell sharply as a result of the sluggish economy.

 

Ultimately, the overheated economic growth rate that surpassed the Heisei bubble period was not sustainable, and it further amplified high inflation and asset bubbles. 

 

 

(2) The Japanese economy has shifted from a deflationary gap to an inflationary gap

 

Even before the release of overheated April-June 2011 GDP statistics announced on August 15, of course, on the price front, the core CPI inflation rate has continued to exceed 2% for the past 15 months. It is a well-known fact that high inflation, equivalent to about twice the price stability target, has continued.

 

We cannot overlook the fact that the new GDP statistics this time appear to be creating an inflationary gap in which aggregate demand exceeds aggregate supply, not only in terms of prices, but also in terms of the realities of the Japanese economy.

 

Based on the GDP statistics for the January-March quarter of 2011, the Bank of Japan has estimated the GDP gap to be -0.3%, where aggregate demand is slightly below aggregate supply, and the gap has narrowed considerably. was On the other hand, the Cabinet Office had estimated that aggregate demand was about 0.7% lower than aggregate supply, and that the GDP gap was still in a deflationary gap.

 

However, according to the GDP statistics for the April-June period, the real GDP level reached 560.7 trillion yen, exceeding the record high of 557.4 trillion yen before the corona crisis by 3.3 trillion yen, or about +0.6% to GDP. plus divergence.

 

Estimating the output gap is rather complicated and subject to error. However, the simple method of calculating the GDP gap that I use is actually secondhanded by the famous Nobel Prize-winning economist, Professor Paul Krugman. On the other hand, it is a convenient way to take the real GDP level at any given time as the aggregate demand level.

 

Therefore, according to Krugman's simple method, Japan's GDP gap in the real economy has already exceeded aggregate demand by +0.6%, and it can be seen that the situation is turning into an inflationary gap. It's the most important thing.

 

If aggregate demand exceeds aggregate supply and is turning into an inflationary gap, what is now required of the economic authorities is to stop stimulating aggregate demand and shift to suppressing aggregate demand. is.

 

 

(3) Japan's inflation is clearly accelerating in the national CPI in July

 

Regarding the notable July consumer price index announced on August 18, the Nikkei Shimbun briefly introduced it as follows in a web article on the same day.

 

“The July consumer price index (CPI, 2020 = 100) announced by the Ministry of Internal Affairs and Communications on the 18th was 105.4, excluding fresh food, which fluctuates greatly, an increase of 3.1% compared to the same month of the previous year. It is the 11th consecutive month that the rate has exceeded 10%, and the growth rate has decreased for the first time in two months due to lower electricity and gas prices.

 

It was at the same level as the median market forecast of 3.1% compiled in advance by QUICK. It is the 23rd consecutive month of increases. Prices continued to exceed the Bank of Japan's price target of 2%, and food prices continued to grow at a high rate.

The composite index, which excludes fresh food and energy, rose 4.3%. Growth expanded for the first time in two months. ”

 

This is not necessarily wrong, but it is not without problems. The reason is that the core CPI, excluding fresh food, appears to have risen only +3.1% in July compared to the previous year, but this is about -1% due to government subsidies for electricity and gas charges. because it is due to the influence of

 

The true core CPI, adding back the -1% subsidies for electricity and gas, corresponds to a core CPI inflation rate of +4.1% y/y.

 

Furthermore, the so-called core-core CPI, excluding fresh food and energy, rose +4.3% y/y in July, surpassing the 4.1% y/y in June. %) clearly marks an acceleration in inflation.

 

Preliminary figures for Tokyo's wards did not show signs of an acceleration in July's CPI increase rate, but on the contrary, the nationwide CPI clearly showed an acceleration in Japan's inflation in July.

 

The proof is better than the theory, and the price level chart of the original statistics is self-explanatory. (Based on 2020 consumer price index nationwide July 2023 (stat.go.jp))

 

 

(4) The BOJ will inevitably raise interest rates not only with the 2% price stability target policy but also with the nominal GDP growth rate target policy

 

The optimal trajectory for Japan's economic growth rate (on a nominal basis) is considered to be around 3% to 4%, which is the sum of the Bank of Japan's 2% price stability target and the Cabinet Office's estimated potential growth rate of approximately 0.5%. Masu.

 

The nominal GDP growth rate of 12%, which is three to four times the optimal nominal GDP growth rate of 3 to 4%, is clearly excessive, and the Japanese economy is already in danger of overheating and spiraling out of control. I have to say that it is expensive.

 

In any case, the continuation of unconventional monetary easing has led to high inflation and a significant depreciation of the yen, and is unnecessarily pushing the Japanese economy into an imbalance.

 

Monetary policy normalization should be seen as urgent now given the extraordinary results of the Q2 GDP data, which has been pushed sharply to record highs in nominal and real terms.

 

It is not wise to disregard Japan's nominal GDP level of 590 trillion yen, which is rapidly approaching 600 trillion yen, as the Nikkei editorial does.

 

This is because GDP is usually said to be a mirror that reflects the overall picture of the Japanese economy from an expenditure perspective, but at the same time, GDP is also a mirror that reflects the equivalence of the three dimensions of production, income, and expenditure.

 

Nominal GDP, which has reached a record high level, does not necessarily bring about an increase in income for general consumers, but it is for specific businesses such as exporters who benefit from the sharp yen depreciation and tourists who enjoy the benefits of inbound tourism. It should have clearly brought about an increase in income for

 

Conversely, production, income, and expenditure in the economy as a whole have become equivalent on all three fronts, pushing Japan's GDP to a record high on both a nominal and real basis.

 

Given the overheated GDP statistics that have surpassed the Heisei bubble period, it is due to external demand, and domestic demand is still weak. If this happens, further acceleration of inflation and expansion of the asset bubble will become inevitable, and the Japanese economy will become uncontrollable, leading to repeated ultimate bursts of the bubble.

 

In short, the normalization of monetary policy, including the Bank of Japan's interest rate hike, is finally imminent.

 

 

⑤ The highlight of the rest of August is the “Jackson Hole Conference”

 

It should be noted that the speech by Chairman Powell of the US Federal Reserve System (FRB) at the international economic symposium "Jackson Hole Conference", which is the largest event of the week and the largest event of the month, will be around 11:00 pm on the 25th of Japan time. It's scheduled after the weekend's witnessing is over and may need attention.

 

This is because, depending on what Fed Chairman Jerome Powell says at the Jackson Hole conference, long-term interest rates in Japan and the United States may resume rising. The market expects that the FRB will maintain its monetary policy at the next US Federal Open Market Committee (FOMC) meeting in September with a probability of about 90%, while the FOMC in November will raise interest rates by 0.25 points with about 30% probability. It seems to be woven with probability. It is said that the important point in Chairman Powell's speech will be whether there will be any remarks that will change the view of the market.

 

Furthermore, the theme of this year's Jackson Hole Conference is "Structural Change in the Global Economy." It is also worth noting whether there is any mention of the natural rate of interest, which is considered to be an interest rate level that is neutral in its impact on the economy and prices. There seems to be a growing debate that the natural rate of interest in the United States may actually be higher than previously thought. Under these circumstances, if Chairman Powell hints at the possibility that the natural rate of interest is rising, he may send hawkish messages to the market, such as ``extension of monetary tightening'' and ``return to rate cuts is far away''. Yahoo Finance points out that there is, and caution is required, and I can't help but see it as quite persuasive.

 

 

(6) Summers' US long-term interest rate forecast is 4.75%

 

Also noteworthy is that during Bloomberg's Wall Street Week last weekend, former Treasury Secretary Summers predicted long-term interest rates of around 4.75%, 50 basis points above current levels.

 

With a real interest rate of about 1.5%, an expected (expected) inflation rate of 2.5%, and a term premium of 0.75%, he justified his long-term interest rate forecast of 4.75%, which I must say is quite convincing. .

 

The author's personal estimate of US long-term interest rates is around 5% based on the real potential growth rate of the US of 2%, the Fed's price stability target of 2%, and the risk premium of US long-term government bonds of about 1%. It's reasonable, and I would also point out that it's roughly consistent with US long-run nominal growth of about 5%.

 

 

Tomo Nakamaru

Former World Bank Economist