This week's weekly: The cabinet reshuffle does not alter the fate of Kishidanomics

 

This week's weekly: The cabinet reshuffle does not alter the fate of Kishidanomics

 

September 19, 2023

 

What does Japan's August PPI imply?

 

(Nakamaru) Last week, Japan's Producer Price Index (PPI) for August of this year was announced by the Bank of Japan. Please summarize the results and media and market evaluations.

 

(Bard) On September 13, 2023, the Producer Price Index for August 2023 announced by the Bank of Japan increased by 0.3% from the previous month (3.2% from the previous year). On a month-on-month basis, it has been positive for two consecutive months since July 2023, but compared to the previous year, growth has slowed down for eight consecutive months.

 

Looking at the breakdown, petroleum and coal products rose by 7.5% from the previous month (7.5% from the previous year) and metal products rose by 3.8% from the previous month (1.8% from the previous year) due to increases in raw material and energy prices. did.

 

On the other hand, prices for electricity, city gas, and water fell sharply, dropping 3.9% from the previous month (up 1.0% from the previous year).

 

The following evaluations were received from the media and market.

• Although the month-on-month increase was positive, the year-on-year comparison continues to slow down.

• Rising raw material and energy prices are placing a heavy cost burden on companies.

• Although the domestic economy is on a recovery trend, rising corporate prices will lead to inflationary pressures.

 

Regarding future trends in corporate prices, trends in raw material and energy prices are expected to continue to be important.

 

Below are some specific reports.

 

•NHK

 

o Producer prices rose 0.3% from the previous month, pushed up by rising raw material prices

o YoY growth slowed for 8 consecutive months

 

• Nihon Keizai Shimbun

 

o Corporate prices rose 0.3% from the previous month, pushed up by raw material prices

o Year-on-year growth slowed for eight consecutive months due to falling electricity prices.

 

These reports suggest that although producer prices have continued to rise, their growth has slowed compared to the previous year due to factors such as the heavy cost burden associated with rising raw material prices and falling electricity rates.

 

 

(Nakamaru) Thank you. However, Japan's August PPI increased by 3.2% year-on-year, significantly exceeding the 1.6% year-on-year increase in August PPI in the United States.

 

It seems better to assume that the reversal in the inflation rate difference between Japan and the US continues in August (Japan's CPI for August is scheduled to be released on the 23rd this weekend).

 

Furthermore, in August, crude oil prices (WTI) soared 7% in dollar terms, and the Japanese yen also depreciated by 2.5% against the US dollar over the month, leading to an increase in inflation in Japan since September. Isn't it wise to downplay the risks?

 

In any case, isn't it dangerous to underestimate or ignore the reversal of the difference in inflation rates between Japan and the United States?

 

(Bard) As you say. Japan's August PPI rose 3.2% year-on-year, significantly higher than the 1.6% year-on-year rise in the US August PPI. Additionally, factors that increase inflationary pressures in Japan remain, such as the weak yen and rising oil prices.

 

Therefore, it would be unwise to downplay the risk of rising inflation in Japan. Furthermore, neglecting or ignoring the reversal of the difference in inflation rates between Japan and the United States could pose a major risk to the Japanese economy.

 

Specifically, the following risks may be considered.

• Rise in consumer prices due to rise in import prices

• Deterioration in profits due to increased cost burden on companies

 

In order to avoid these risks, it is important for the Bank of Japan to respond to monetary policy and for the government to implement economic measures. It will be necessary to continue to closely monitor Japan's inflation trends.

Clouded US August CPI

 

(Nakamaru) Please summarize last week's US August CPI results.

 

Note, however former Treasury Secretary Summers is skeptical about the outlook for inflation, and says that there might be still two more rate hikes left by the Federal Reserve, and he remains skeptical about a soft landing for the US economy...?

 

Isn't the market's complacency, as seen in the VIX index (fear index), which has fallen significantly to around 13-14%, the lowest level since the beginning of the year, going too far?

 

(Bing) Let's summarize the results of the US August CPI and the reactions of the media and financial markets.

 

• The US August CPI increased by 3.7% compared to the same month last year, showing faster than expected growth. Month-on-month, it rose 0.6%, accelerating from 0.2% in July. The main factors were increases in airfares and automobile-related prices1.

 

• Core CPI (excluding food and energy) rose 4.3% year-on-year, slowing as expected but at its lowest level since September 2021. It rose 0.3% from the previous month, exceeding expectations.

 

Former Treasury Secretary Summers is skeptical about the outlook for inflation, and says there are still two more rate hikes left by the Fed, so he seems skeptical about a soft landing for the U.S. economy...?

 

• Summers said in an interview that U.S. inflation will be "very close" to 5% at the end of the year, requiring the Fed to raise the federal funds rate by 50 basis points or more above current levels.

 

• Summers also expressed concern that the U.S. budget deficit is projected to reach 7.3% of GDP in fiscal year 2033, arguing that government spending cuts are unrealistic and will require tax increases. did.

 

• Mr. Summers' views are at odds with those of the Fed and the Biden administration, and there are also objections and criticisms from the market. The Federal Reserve expects inflation to be temporary and to slow next year, and is cautious about the timing and pace of interest rate hikes. The Biden administration is promoting increased fiscal spending and is considering measures such as tax reform and social security system reform.

 

Isn't the market's arrogance, as seen in the VIX index (fear index), which has fallen to around 13-14%, going too far?

 

• The VIX index is an index that shows expected fluctuations in the stock market, and the higher it is, the more anxious investors are. The fact that the VIX index has fallen to around 13-14% can be said to indicate that the market is in a stable state.

 

• However, there is also a danger that market stability may lead to complacency. The VIX index has risen sharply many times in the past, each time causing major turmoil in the stock market. For example, during the 2008 financial crisis and the 2020 coronavirus outbreak, the VIX index reached levels above 80%.

 

• There are currently risk factors in the market, such as inflation, rising interest rates, another spike in oil prices, and a strike by the United Auto Workers union. If these factors worsen, the VIX index could rise again and affect the stock market. Therefore, I think we cannot ignore the question of whether the market's complacency has gone too far.

It is unusual for Sankei and Nikkei editorials to openly disagree with the continuation of Kishidanomics.

 

The Nikkei editorial published this Monday, the 18th, in response to the Sankei editorial that had already been published the day before, ``Economic measures in October - don't fall into the 'scale-based'' approach'', saying, ``Let's stop having a package-based policy.''  It appears that a counter-attack against the continuation of Kishidanomics has begun with the two papers.

 

For instance, the Nikkei editorial stated, ``We should strictly refrain from taking economic measures in bulk, which build up scale based on old ideas.  In fact, they may only encourage higher prices and even have the opposite effect.''  In fiscal 2020, the government set up a huge supplementary budget of 73 trillion yen, and in fiscal 2021 it amounted to 36 trillion yen.  In fiscal 2022, when the virus had subsided, there was pressure on the ruling party to put scale first, and the second supplementary budget was put in place in fiscal 2022.  29 trillion yen was added. If the prime minister's “drastic'' idea is the same, then it is a mistake.”, emphasized the editorial.

 

“Furthermore, the Cabinet Office estimates that the ``output gap'' in the April-June period turned positive, eliminating nearly four years of demand shortage. This is not the time to stimulate the economy with large amounts of fiscal spending. If countermeasures are to be taken, they should be robust and will transform the constitution of the Japanese economy. ", it continued.

 

The editorial went on to say, ``First of all, we need to make it sufficiently targeted and highly effective.'' He added, “The focus is on measures to counter high prices.'' Subsidies to oil wholesalers and electricity and city gas companies will lower gasoline and electricity prices. The deadline for the measures to reduce carbon emissions will expire at the end of the year, and there are plans to continue them beyond 2024. However, it is clear that this will distort market pricing and go against decarbonization. Instead of distributing fiscal funds blindly, we need to find ways to focus on supporting low-income households, small and medium-sized enterprises, and micro-enterprises."

 

In addition, ``The government has clearly stated in its basic economic and fiscal management and reform policies (substantial policies) that it will　“return'' the structure of expenditures to normal times. With increases in defense spending and spending to counter the declining birthrate on the horizon, it is necessary to pay close attention to fiscal discipline. The huge amount of reserve funds that have become noticeable in recent years is out of the question. The Prime Minister said, ”A Cabinet that empowers change.'' If they resort to short-term painkillers aimed at boosting their approval ratings, the billboards will fall. We hope for wise economic management that will strengthen Japan over the medium to long term. ”  concluded the editorial.

 

Kishida and Ueda play cat and mouse

 

(Nakamaru)        Both the Sankei and Nikkei editorials can be highly praised for their persuasive arguments.

 

However, if things continue as they are, Japan will fall into a cat-and-mouse game of continuing a different level of monetary easing and repeating a different level of fiscal expansion using price countermeasures as the rationale. There is no doubt that the economy will continue to overheat for the time being, leading to higher inflation and further amplification of asset bubbles.

 

As inflation has continued to exceed 2% for the past 16 months, on the one hand, the Bank of Japan has continued to implement monetary easing on a different level, including negative policy interest rates, and on the other hand, the Kishida Second Reshuffled Cabinet has announced a policy of ``to keep up with rising prices''. It appears that Japan intends to continue fiscal expansion by "strengthening structural wage increases and investment flows."

 

However, the Japanese economy has turned into an inflation gap where aggregate demand exceeds aggregate supply. Macroeconomics teaches that in the case of an inflation gap, measures to suppress aggregate demand should be adopted through monetary policy, fiscal policy, or both.

 

On the contrary to economic theory, if Japan continues to implement measures to stimulate aggregate demand with extensive monetary and fiscal measures, it will be inevitable that Japan will suffer another major defeat in the fight against inflation. Unfortunately, I cannot help but think that Japan has not yet learned the true nature of failure in the WWII.

 

  (Bard) Yes, you are correct. Japan's inflation rate has continued to exceed 2% for the past 16 months. However, the Japanese government and the Bank of Japan have shown a willingness to continue monetary easing and fiscal expansion.

 

This attitude is contrary to macroeconomic theory. When an inflation gap exists, it is necessary to suppress aggregate demand through monetary policy, fiscal policy, or both. However, the Japanese government and the Bank of Japan are likely to exacerbate inflation further by continuing with policies that stimulate aggregate demand.

 

There is a very high possibility that Japan will fail in its anti-inflation measures and lose the fight against inflation. This can be said to be a sign that Japan has not learned the ``essence of failure.''

 

For Japan to succeed in combating inflation, the following points are important.

 

• Mobilize monetary and fiscal policies to suppress aggregate demand

• Make the people understand the need for inflation countermeasures and gain their cooperation.

 

Future developments will be closely watched to see whether the Japanese government and the Bank of Japan will be able to overcome these challenges and succeed in combating inflation.

 

Below are some possibilities if Japan fails to combat inflation.

• Acceleration of price increases

• Slower economic growth

• Deterioration of people's lives

• Increased social unrest

 

These problems could arise if Japan fails to combat inflation. It is important for the Japanese government and the Bank of Japan to recognize the risk of failing to combat inflation and take appropriate measures.

 

(Nakamaru) Unfortunately, Bard is right.  Let us discuss the “essence of failure'' again in next week's monthly newsletter. Please look forward to it.

 

Tomo Nakamaru

Former World Bank Economist