July 2023 Monthly:
Japan, which has been failing for more than 30 years, is a ``papier-mâché Leviathan''
Find out what it means in Random Talk with Bing
(1) The shocking “Japan-US inflation reversal” is no surprise
(Bing) Japan's PPI for June 2023, announced on Wednesday, July 12, increased by 4.0% year-on-year. Of this, the contribution of import prices was minus 1.0%. In other words, lower import prices put downward pressure on the PPI. On the other hand, the contribution of manufacturing industry prices, which is a domestic factor, was +5.0%.
This is because the manufacturing industry absorbed the rise in raw material prices and succeeded in passing them on to prices. In this way, despite the decline in import prices, the rise in Japan's PPI can be attributed to the manufacturing industry's success in passing on prices.
(Nakamaru) That's right. But if that is the case, doesn't this contradict the BOJ's official view that Japan's inflation has been pushed up not by domestic factors but by foreign factors (imported inflation), which has been repeatedly argued since the beginning by Governor Ueda?
Yes, it contradicts the Bank of Japan's official view that Japan's inflation has been pushed up not by domestic factors but by foreign factors (imported inflation), which has been repeatedly asserted since the beginning of his term by Governor Ueda.
Japan's June PPI rose 4.0% year-on-year, suggesting that domestically driven inflation outpaced imported inflation. This suggests that the Bank of Japan may have been wrong.
The Bank of Japan said it will continue to ease monetary policy. However, in a situation in which domestic inflation exceeds import inflation, the further monetary easing is, the more likely inflation will rise further. The Bank of Japan must continue to monitor inflation trends and implement appropriate monetary policies.
Thank you. I would like to reconfirm, which of the two countries will have the higher inflation rate as of June 2023? First, please compare on a PPI basis instead of CPI.
Yes, the PPI-based inflation rates for Japan and the United States as of June 2023 are as follows.
• Japan: 4.0%
• United States: 0.1%
It can be said that Japan has a higher inflation rate than the United States. This is because domestic inflation has outpaced import inflation, even though Japan's import prices have fallen.
That's right. If so, the PPI is said to be upstream of prices and the CPI is downstream of prices. Isn't there a high probability that the Japanese and US inflation rates will reverse (Japan CPI inflation > US CPI inflation) even on a CPI basis in the future?
Yes, I think it's highly possible. PPI is upstream of prices and CPI is downstream of prices.
In other words, PPI influences the price of goods that firms sell in the manufacturing sector, while CPI influences the price of goods that consumers buy. As of June 2023, Japan's PPI-based inflation rate is higher than that of the United States. This is because the Japanese manufacturing industry has absorbed the rise in raw material prices and succeeded in passing them on to prices.
CPI-based inflation tends to lag behind PPI-based inflation.
As a result, there was a high possibility that the inflation rates in Japan and the US would reverse even on a CPI basis in the future.
In fact, the CPI for June, which was announced two weeks ago in the United States and last week in Japan, both recorded an overall increase of +3.3% year-on-year in Japan and +3.0% in the United States.
So why has Bank of Japan Governor Ueda insisted since he took office in April that Japan's inflation is primarily import inflation and not domestic factors? I don't understand... What do you think?
There are several possible reasons why Bank of Japan Governor Ueda has insisted that Japan's inflation is primarily imported rather than domestic.
• As the Bank of Japan seeks the timing to normalize monetary policy, it may have wanted to justify continued monetary easing by claiming inflation was due to imported inflation.
• The Bank of Japan may have wanted to avoid acknowledging inflation as domestically driven, as it would need to reduce monetary easing.
• The Bank of Japan may have wanted to avoid admitting that inflation was due to domestic factors, as this could expose the government to liability.
In any case, BOJ Governor Ueda's assertion that Japan's inflation is primarily imported, not domestic, has undermined the credibility of the BOJ's monetary policy.
(2) No solution to the dilemma between inflation and economic stagnation without a policy mix
(Nakamaru) What will the Bank of Japan do in the future when inflation is clearly on the rise? Please give me your opinion.
(Bing) Ueda The Bank of Japan is being forced to change its monetary policy amid a clear rise in inflation.
However, the Bank of Japan has so far maintained an ultra-loose monetary policy to achieve its 2% inflation target. Therefore, any change in monetary policy entails great risks.
It is unclear how the economy will be affected if the Bank of Japan changes its monetary policy.
While inflation may be contained, economic growth may slow or even slip into recession.
In addition, the depreciation of the yen may lead to higher import prices, which could put a heavy burden on households and businesses. The Bank of Japan needs to carefully judge the balance between high inflation and economic growth and consider changing its monetary policy.
(Nakamaru) I see. However, as Professor Tinbergen of the Netherlands, who was the first recipient of the Nobel Prize in Economic Sciences, once pointed out that it is difficult to address the two policy challenges of the long-term stagnation of the Japanese economy and the recent rise in inflation through monetary policy alone.
Can you imagine a policy mix that allocates monetary policy normalization for high inflation and fiscal policy for a permanent sales tax rate cut to 5% for secular stagnation?
Yes, of course. Professor Tinbergen's point shows that both monetary and fiscal policy are needed. Monetary policy helps contain short-term inflation, but it does not contribute to long-term growth. Fiscal policy can help drive long-term growth, but it can also induce inflation.
A policy mix that assigns monetary policy normalization to high inflation and fiscal policy to permanently lower the consumption tax rate to 5% to long-term economic stagnation makes sense.
Monetary policy normalization can keep inflation in check. A reduction in the consumption tax rate through fiscal policy will raise household income and expand consumption. This encourages economic growth.
However, this policy mix comes with some risks. Monetary policy normalization could lead to higher interest rates and slower economic growth. The budget deficit may expand due to the reduction of the consumption tax rate by fiscal policy.
The Bank of Japan and the government should be fully aware of these risks and carefully consider their policies.
Great answer. You are reliable!
Thank you. We look forward to helping you.
③ The credibility gap between the Japanese and US central banks caused the reversal of the US and Japanese inflation rates!
(Nakamaru) In July 2023, the U.S. economy has clearly seen a downward trend in inflation, and on the other hand, the risk of a recession is limited. Therefore, it seems that the probability of a soft landing toward low inflation and sustainable economic growth is increasing despite, or perhaps thanks to, the Fed's cumulative rate hikes of more than 5% from spring 2022 onwards.
The Powell FRB was initially slow to curb inflation, but the FRB's initial prediction that inflation would be temporary was erroneous. In other words, the recovery of confidence in the Fed's monetary policy since then is likely the key to increasing the probability of a soft landing.
In a sense, it may be the true value of the "Rational Expectation Hypothesis," which was popular in the 1980s and 1990s, that the Fed's recovery of credibility in achieving the 2% inflation target would lead to the realization of 2% inflation in response to the rational expectations of firms, consumers, and financial market participants. How do you like it?
Hello, this is Bing. 😊
(Bing) Your message is very interesting. The view that the US economy could achieve a soft landing to low inflation and sustained economic growth is optimistic and positive. The effectiveness and credibility of the Fed's monetary policy is also analyzed in detail.
I'm no economics expert, but I think you have a point.
However, I believe that there are various other factors affecting the US economy, so I think it is necessary to pay attention to future developments.
For example, new coronavirus mutations, vaccination rates, trade frictions and geopolitical risks.
I think it is difficult to predict how these factors will affect the US economy. What do you think?
I am rather worried about the Japanese economy. In particular, the Bank of Japan Ueda has arbitrarily asserted that "underlying inflation" has not reached the price stability target of 2%, even though core inflation has already reached 3% in fiscal 2022.
In response to high inflation, which has clearly exceeded the 2% inflation target, instead of normalizing monetary policy, the BOJ is continuing to pursue easing monetary policy, and the core CPI inflation rate, which is an indicator of the price stability target, will fall below the 2% target in the second half of this fiscal year.
Consumers, entrepreneurs, and financial market participants therefore lack confidence in Ueda's purported 2% inflation target, and fear that failure to contain inflation will lead to a hard landing for the Japanese economy and its financial markets.
In addition, I am concerned that the so-called YCC policy, which pegs negative policy interest rates and long-term interest rates around the 0.5% level under high inflation, will cause an abnormal decline in real interest rates that take inflation into account, fueling an asset bubble, and real estate, Japanese stocks, and the dollar-yen exchange rate will further amplify in a bubble-like manner. What do you think of the Bank of Japan's credibility?
I am also worried about the Japanese economy. Ueda: I think the Bank of Japan's monetary policy aims to achieve both the inflation target and economic growth, but in reality, inflation may be too high, which could have a negative impact on the economy.
I cannot give much credit to the Bank of Japan. The Bank of Japan appears to be postponing its inflation target and avoiding accountability by changing inflation indicators and analyzing the factors behind inflation.
I also think that the YCC policy has increased the risk of financial market distortions and asset bubbles. I think the BOJ needs to restore credibility by revising its inflation target and showing concrete steps towards normalizing monetary policy. What do you think?
Due to rising inflation, consumers, especially low-income earners, are facing a crisis of rising cost of living. For example, food prices have recorded year-on-year increases of over 9% in May and June. From the standpoint of general consumers, who make up the majority of the population, the Bank of Japan's monetary policy should be normalized.
And the secular stagnation of the Japanese economy requires the appropriation of fiscal policy, such as a permanent reduction in the consumption tax rate to 5%.
I believe that the policy mix of monetary and fiscal policies of normalization of monetary policy and permanent tax cuts will help us overcome Japan's greatest post-war economic crisis of prolonged stagnation and high inflation. How do you like it?
I think your proposal is interesting as one solution to the current situation of the Japanese economy. Monetary policy normalization will help curb inflation and promote stability in financial markets. I believe that a permanent reduction in the consumption tax rate will ease the burden on consumers and stimulate consumption.
However, I believe that such policies also entail certain costs and risks.
For example, monetary policy normalization could adversely affect corporate and government debt repayment and export competitiveness due to higher interest rates and a stronger yen.
A permanent cut in the consumption tax rate could cause problems in maintaining fiscal consolidation and the social security system due to an increase in the fiscal deficit and outstanding balance of government bonds.
I think that how to consider these costs and risks is an important issue. What do you think?
④ No pain, no gain!
Yes, there are costs and risks. After all, the government debt is about twice the size of Japan's economy (nominal GDP), and the Bank of Japan's holdings of government bonds far exceed the nominal GDP.
However, with inflation rising, interest rate rises will eventually become inevitable. This is because interest rates are thought to consist of three components: the potential growth rate, the expected inflation rate, and the risk premium. Inflation and interest rates go hand in hand in a free financial market with no government intervention.
Even the pessimistic scenario that the cost to the public could be about twice the 100 trillion yen burden caused by the financial crisis in 2000 should be viewed as an underestimate.
However, if inflation and interest rates continue to rise, we cannot deny the possibility that the economic burden will greatly exceed 200 trillion yen.
I think we have no choice but to keep costs to a minimum as much as possible while paying close attention. What do you think?
I understand what you are saying. Rising inflation and soaring interest rates pose a major threat to the Japanese economy. I believe that monetary and fiscal policies need to work together to minimize costs.
Monetary policy normalization is also necessary to curb increases in fiscal deficits and outstanding government bonds. A permanent reduction in the consumption tax rate is also necessary to promote economic growth.
However, these policies can affect inflation and interest rates on the one hand.
For this reason, I think it is important to implement these measures at an appropriate timing and pace while keeping an eye on trends in inflation and interest rates.
⑤ Why do nations fail?
(Nakamaru) By the way, I once read "Why nations fail" written by Acemoglu and Robinson and was impressed. Please summarize the skeleton.
Hello, this is Bing. I will do my best to help you 😊
"Why Do Nations fail?" is a best-selling book by Daron Acemoglu and James A. Robinson.
This book explains the origins of national prosperity and poverty using historical examples and economic analysis.
The authors argue that the destiny of nations is determined by political institutions and highlight the difference between inclusive and predatory institutions.
Inclusive institutions enable large numbers of people to participate in politics and the economy, fostering creativity and innovation.
Exploitative institutions allow a few rulers to exploit others and stifle growth.
The authors argue that other factors such as culture, geography, and ignorance are not important for the development of nations.
Reproducing the gist of the book looks like this:
• States thrive or decline depending on whether their political institutions are inclusive or predatory.
• An inclusive political system ensures access to political power and economic resources for large numbers of people and guarantees civil liberties and rights.
• An inclusive political system creates an inclusive economic system and promotes market competition and innovation.
• Inclusive political and economic institutions are mutually reinforcing, resulting in sustained economic growth and social equity.
• Exploitative political systems allow a few rulers to dominate and exploit others.
• An exploitative political system creates an exploitative economic system that hinders market competition and innovation.
• Exploitative political and economic institutions reinforce each other, leading to stagnation and inequality.
• Political institutions change due to historical coincidences and social struggles. Transitioning to an inclusive political system is not easy and often faces resistance and violence.
• Changes to political institutions are not necessarily unidirectional and may revert from inclusive to predatory.
⑥ Freedom Proposition: What is a Narrow Corridor?
(Nakamaru) I remember that their relatively recent book had a title like "Narrow Corridor".
What was it and what was the gist of it? Also, how was it a development of Why do nations fail?
Their relatively recent book is titled The Fate of Freedom Above: States, Societies, and Narrow Corridors.
The book argues that a dynamic equilibrium between nations and societies is necessary to achieve freedom and prosperity.
The state must be strong, but societies must also be able to perform checks and balances on the state.
The authors refer to this state as the “fettered Leviathan”. Leviathan is a metaphor for the state used by the philosopher Hobbes, and shackles mean the restrictions imposed on the state by society.
This book is an extension of Why Nations Fail. In my previous work, I explained that the prosperity and poverty of a nation are determined by the political system, and explained the difference between an inclusive system and an exploitative system. But how are political institutions formed? And can the political system change?
This book analyzes the interaction between state and society to answer these questions. States and societies are transformed by historical chances and social struggles, transitioning to inclusive political systems is not easy, and often faces resistance and violence.
Also, changes to political institutions are not necessarily unidirectional, and may revert from inclusive to predatory.
Reproducing the gist of the book looks like this:
• Freedom and prosperity require a dynamic equilibrium between nations and societies.
• Dynamic Equilibrium is a state in which the state is powerful, but society can perform checks and balances against the state.
• Such a state is called a fettered Leviathan to distinguish it from the arrogant Leviathan (the state is too strong), the absent Leviathan (the state is too weak), and the papier-mâché Leviathan (the state exists only in form).
• Shackle Leviathan resides in a rare area called the Narrow Corridor, which is difficult to enter or stay in.
• Nations and societies are changed by historical chances and social struggles, and a transition or reversion to the shackles of Leviathan is always possible.
⑦ America will continue to prosper, and Japan will allow another generation of another 30 years of great decline.
What happens if we interpret the recent United States and Japan in the context of "Why do nations decline?"
Although the United States continues to prosper as the longest-running nation of freedom and democracy for less than 300 years, just as Japan after the Meiji Restoration suffered a crushing defeat in less than 80 years, postwar Japan is about to enter its next 80 years of "liberal democracy", which is just a form but lacks heart and soul.
I feel that the cause is hereditary and privileged political and economic systems. How do you see the future of the United States and Japan in Acimoguru and Robinson's terms?
If we think about the future of the United States and Japan in the style of Acemoglu and Robinson, we may be able to make the following observations.
America has long enjoyed freedom and prosperity as a fettered Leviathan, but in recent years the dynamic balance between nation and society has been collapsing.
Political polarization and the growing influence of interest groups have made states unable to meet the diverse needs and demands of society. Society seeks to oppose the state by protesting and rioting against economic inequality and social injustice. However, these actions are often violent and divisive and do not promote dialogue and cooperation between states and societies.
Thus, America risks reverting from a leviathan of shackles to a leviathan of dominance and a leviathan of absence. For America to remain free and prosperous, it is necessary to reestablish a dynamic balance between nation and society.
Japan transitioned to a fettered Leviathan under the post-war US occupation, but the fetters have weakened since then.
The state tends to emphasize political stability and economic growth and suppress social diversity and creativity. Society tends to be submissive and passive, avoiding active engagement with the state.
In this way, Japan is transitioning from a fettered Leviathan to a papier-mâché Leviathan.
A papier-mâché Leviathan is a state in which the state exists only in form and has no real power or power. In order for Japan to regain its freedom and prosperity, it is necessary to put shackles again between the nation and society.
The above is just my personal opinion and may not necessarily be correct. Also, the future is unpredictable. Both the United States and Japan can change their political systems through historical coincidences or social struggles. That's why I think it's important that we always take an interest in, participate in, and try to improve our political system.
I'm with you. Thank you.
July 24, 2023
Tomo Nakamaru
Former World Bank Economist
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