This week's weekly: Japan continues to quietly decline due to the "absence of common sense policy"

 

This week's weekly: Japan continues to quietly decline due to the "absence of common sense policy"

 

 

October 2, 2023

 

Is it true that ``the monetary policy operation will not be impaired by a temporary deficit or excess debt at the exit''?

 

According to an article in the Tokyo Shimbun from last weekend, “Bank of Japan Governor Kazuo Ueda gave a speech on the 30th at the Japan Society of Monetary Studies held in Fukuoka, saying that in the exit phase of large-scale monetary easing measures, financial soundness needs to be improved.''

 

In addition, ``In the exit phase, interest rates will rise and interest payments to financial institutions that hold current accounts at the Bank of Japan will increase, pushing down the Bank of Japan's profits. There are also concerns in the market that financial deterioration will reduce confidence in the currency. Mr. Ueda said, ``Even if we temporarily run into deficits or surplus debt, our ability to manage policy will not be impaired.'' the article continued.

 

However, he added, ``It's not okay to have deficits or excess debt,'' and ``if confidence in the central bank declines due to declines in profits and capital, it will have a negative impact on policy management.''

 

Furthermore, Governor Ueda described his speech at the Japan Society of Monetary Studies as part of the Bank of Japan's “comprehensive review,'' which he had promised since the beginning of his appointment.

 

However, it must be said that there is considerable room for doubt that even if the Bank of Japan becomes insolvent, its ability to conduct policy will not be impaired.

 

Indeed, even if the Bank of Japan were to become insolvent, there is no doubt that it would eventually be rescued by capital injection from the government.

 

So, where will the funds for the Bank of Japan's capital injection from the government come from?

 

Obviously, it is nothing but the people's tax money.

 

Furthermore, amid high inflation and rapidly rising interest rates, it could cause or amplify losses and debt crisis for consumers, who suffer from high inflation taxes, households, businesses, and private financial institutions, who suffer from rapidly rising interest rates.

 

In short, it is self-evident that the Bank of Japan, as a central bank, must not only address its own excessive debt problem, but must also look at Japan's national economy as a whole.

 

In the end, as Bank of Japan Governor Ueda points out, unless high inflation is brought under control, the Bank of Japan will be unable to control the national economy, even if the excess debt due to rising prices and soaring interest rates is bailed out through capital injections by the government at the people's expense. Saving them must be extremely difficult.

 

 

High prices, statistics that can't keep up, the gap with "experience" expands to double digits

 

According to the top article in the Nihon Keizai Shimbun morning edition dated October 1, ``Statistics are unable to catch up with high prices, the gap with 'experience' widens to double digits,'' there are concerns that price standards are outdated and out of sync with actual living conditions, which has been pointed out.

 

Specifically, the typical consumer price index is a system in which the prices of various products are added up according to the average shopping percentage in the past.  Rapid movements are said to be difficult to reflect.

 

For this reason, there is a view that statistics may not be keeping up with rising prices.

 

Questions have also been raised about how much the inflation rate will change if the standards are updated, and how the Ministry of Internal Affairs and Communications and the Bank of Japan view the fluctuations in the figures.

 

In any case, Japan's CPI has been pushed down by about 1% year-on-year due to government subsidies for electricity and gas utilities, and there is an underestimation bias, as detailed in the September monthly report.

 

In addition, due to significant changes in the consumption structure, there appears to be an even greater underestimation bias.

 

 

How do you compare the Tokyo ward CPI and the national CPI year-on-year change?

 

Under such circumstances, the September CPI for Tokyo's wards announced by the Ministry of Internal Affairs and Communications on September 29 was slightly lower than market expectations, which was rather surprising given the inflationary macro-economic policies being undertaken by the BOJ and the government.

 

Therefore, let's clarify the differences between the Tokyo wards and the national CPI.

 

First of all, it goes without saying that the Tokyo metropolitan area CPI is only a preliminary figure up to the middle of each month.

 

Second, although the Tokyo ward CPI is said to be a leading index of the national CPI in the same month, although there is a correlation between the Tokyo and national CPIs, as the table below shows.  It cannot be overlooked that considerable differences have often occurred.   For example, the year-on-year comparison is not less than 0.3 percentage points mismatches occurred in the recent past on the year-on-year comparison.  In fact, the Tokyo metropolitan area CPI has been often revised at a later date after the preliminary figures are released.

 

Thirdly, in any case, the national CPI has recently tended to deviate upward by about +0.2% to +0.4% compared to the Tokyo CPI. The reason for this is not clear, but it may be a reflection of the fact that the goods and services market appears to be more competitive in the wards of Tokyo, or that the automobile society is becoming more dominant in rural areas.

 

Fourth, compared to the previous month, the September CPI in the wards of Tokyo only increased by +0.2%, +0.0%, and +0.1% on an overall, core, and core-core basis, respectively.

 

In April, the dollar appreciated and the yen depreciated by about 1.6% over the month from 145.54 yen to 149.36 yen (yen depreciated), and crude oil prices also increased by 5.2% on a monthly basis from about 85 dollars per barrel to about 91 dollars in dollar terms.

 

Given this, and in a macroeconomic policy environment in which Japan's monetary and fiscal policies are both highly stimulative and could amplify the acceleration of inflation, it is likely that it is rather difficult to see that a decline in prices will continue to occur without normalization of monetary policy by the Bank of Japan.

 

In short, the phenomenon that appears at first glance to be a decline in inflation in the September CPI for Tokyo's wards, even if it is seen in the national CPI for the same month, could be seen as nothing more than temporary noise. The national CPI for September is scheduled to be released on October 22nd.

 

Year-on-year comparison                                                                                                    Tokyo CPI National CPI Tky Core Nat Core Tky Core Core Nat Core Core

 

Aug-22                2.9         3.0         2.6         2.8         1.4         1.6

Sep-22                 2.8         3.0         2.8         3.0         1.7         1.8

Oct-22                3.5         3.7         3.4         3.6         2.2          2.5

Nov-22                3.7         3.8         3.6         3.7         2.4          2.8

Dec-22                3.9         4.0         3.9         4.0         2.7         3.0

Jan-23                 4.4         4.3         4.3         4.2         3.0          3.2

Feb-23                3.4         3.3         3.3         3.1         3.1         3.5

Mar-23                3.3         3.2         3.2         3.1         3.4          3.8

Apr-23                 3.5         3.5         3.5         3.4         3.8         4.1

May-23               3.2         3.2         3.1         3.2         3.9          4.3

Jun-23                 3.2         3.3         3.2         3.3         3.8          4.2

Jul-23                  3.2         3.3         3.0         3.1         4.0         4.3

Aug-23                2.9         3.2         2.8         3.1         4.0         4.3

Sep-23                 2.8                       2.5                     3.8

 

Japan's August unemployment rate of 2.8% is lower than the natural unemployment rate of 3.2%, and the labor market is extremely tight.

 

Based on the GDP statistics for the April-June quarter, it is clear that the Japanese economy has already seen a shift in the GDP gap from a deflationary gap in which aggregate demand is lower than aggregate supply to an inflationary gap in which aggregate demand slightly exceeds aggregate supply.

 

Economics teaches that a deflationary gap calls for a policy to stimulate aggregate demand, while an inflationary gap calls for a policy to suppress aggregate demand.

 

So, rather than the goods and services market, in the labor market, where rising wages have recently been the focus of the government and the Bank of Japan, the supply and demand balance has become too tight, and instead of a virtuous cycle of wages and prices, it has turned into a vicious cycle of inflationary spirals.  Isn't there any risk of falling into this?  Too much can be as bad as too little.

 

In economics, the unemployment rate at which supply and demand are balanced in the labor market is called the natural unemployment rate or the unemployment rate that does not accelerate inflation (NAIRU). However, it is not easy to determine them theoretically and numerically.

 

Therefore, the first step is to focus on past trends in the unemployment rate, which is basic data in the labor market.

 

As the table below shows, Japan's unemployment rate of 2.8% as of August has been on a slight upward trend recently, but it is still extremely low from a historical perspective, clearly indicating a rather tight labor market.

 

Assuming that the unemployment rate since 1970 is 3.2%, which is extremely low from a historical perspective (therefore, assuming an extremely tight labor market), the Taylor rule, styled by US Treasury Secretary Yellen, is based on the unemployment rate rather than the output gap. If we calculate the policy interest rate that should be as shown in the diagram below, we have to say that there is a strong possibility that the Bank of Japan will be forced to raise interest rates rapidly and significantly due to rising inflation.

 

Policy interest rate Unemployment rate Inflation rate (CPI)

Average since 1970            2.4                       3.2                       2.5

Average since 1980            1.7                       3.5                       1.0

Average since 1990            0.7                       3.8                        0.5

Average since 2000            0.1                       4.1                       0.2

 

Japan continues to quietly decline due to the “absence of common sense policies”

 

I would like to introduce the final part of the sensational Toyo Keizai Online article, dated at the end of September, titled ``When did economists and politicians become so stupid?'' below, in blue text.

 

The author is Professor Akira Obata of Keio University, and the subtitle is ``What kind of economic policy does Japan really need?'' and it is quite persuasive.

 

In any case, I'm only half joking, but I'm relieved to know that there are economists in our country who aren't stupid.

 

The most important thing in this world is how to solve unprecedented problems when they arise. The current economy is rapidly changing and complex, and problems that have never been experienced before are occurring one after another. In order to deal with this, they sought evidence, academic, empirical and analytical arguments, and as a result, they lost the ability to speak up for themselves.

 

In principle, no evidence exists in the unexperienced zone. How do we tackle that? It is necessary to make efforts to somehow find a way by making careful and broad-minded observations without preconceived notions and applying logic and common sense to them, but even that effort is no longer being made.

 

In other words, the above-mentioned desire for a one-shot solution by politicians and public opinion, specifically, subsidies for coronavirus countermeasures and inflation countermeasures. In these cases, we end up sparing time and effort in building a careful system, and end up arguing that ``we'll just have to spread it out all at once.''

 

On the one hand, there are these violent discussions, there are serious and narrow-minded academics who demand extremely detailed evidence. This extreme polarization has resulted in the absence of policies based on common sense. As a result, there has been a cessation of thinking, politicians and economists have continued to act in ways that appear to be idiots, and Japan's economy has continued to quietly decline due to lack of policy measures.

 

Finally, I will present a policy based on common sense.

 

First, inflation. When inflation occurs, the value of your savings and salary decreases. Therefore, we have no choice but to cut down on consumption and save money. Inflation is bad. In fact, it is desirable for consumers that prices do not rise.

 

It is scary to live in a deflationary spiral, where the prices of goods are falling endlessly. However, unlike during the Great Depression, there are no unemployed people in the city today, and prices have not gone up, but have not plummeted.

 

If we stop the depreciation of the yen, most of the problems will be solved.

 

So, what about the weak yen? I can't go on a trip abroad. Important land, companies, and human resources are being bought up and taken away by foreign investors. Moreover, Japan will become poorer.

 

The reason that incomes are lower than in South Korea is solely due to the weaker yen. More than half of the current inflation is caused by the weak yen. Therefore, most of the problems will be resolved if the excessive depreciation of the yen is resolved and the yen returns to a reasonable level of around 90 yen to the dollar.

 

How is the economy? Japan's economy is doing well. There is not even a deflationary gap (in the first place, the deflationary gap is data that is always biased in the direction that it exists). Unemployment rate is extremely low. Everyone is suffering from a lack of manpower. Workers are disappearing not only in big cities like Kagoshima and Aomori, but all over Japan.

 

The economy is not the problem. There is no need for any economic stimulus measures. There is no need to stimulate demand or consumption. The problem is the decline in real income, and if the yen's depreciation were stopped, inflation would be reduced and the problem would be solved.

 

Is there a virtuous cycle between prices and wages? Such a thing does not exist. In the history of economies around the world, there has never been a time when wages have risen faster than prices and the economy has improved. Impossible. At best, this is stagflation (increasing prices during an economic downturn).

 

To begin with, half of the Japanese population has no earned income. If prices rise, all citizens will suffer. Wages are taken away from companies through negotiation, such as when people change jobs. There is no reason why inflation would lead to higher wages without bargaining. This only increases the number of bargaining chips that come with inflation.

 

Of course, for companies that are already suffering from high raw material prices, raising wages will make costs even higher. Therefore, there is no reason for wages to rise more than the inflation rate in the economy as a whole. It's the opposite. Real wages will inevitably fall.

 

How to curb inflation and increase real wages?

 

In fact, in Japan, real wages have fallen for 16 consecutive months since inflation started, and the rate of decline is widening. The only way to raise real wages is to eliminate inflation. If individual workers can increase their productivity, wages will rise. Therefore, stopping inflation and lowering prices is the only way to increase real wages.

 

If you look at the real world, it's obvious that this is the case in America, and even worse in Europe. In the UK, the worst vicious cycle is the rise in wages caused by rising prices, and the country is desperately trying to break this cycle. Of course, wages can't keep up with prices everywhere, and no one is saying it's a virtuous cycle. On the contrary, everyone recognizes that it is the most powerful vicious cycle.

 

Finally, what do you think of the Bank of Japan's monetary policy? End of negative interest rates and end of yield curve control (manipulation of long-term and short-term interest rates). These two things should be done immediately.

 

One of the reasons for the weak yen is the Bank of Japan's unusual easing measures. Therefore, it should be stopped. However, there is an excellent economist who seriously says, ``Monetary policy should not affect exchange rates, so policy should not be changed based on the weak yen.''

 

I don't understand. Look at the reality. The yen's depreciation is occurring because the Bank of Japan's monetary policy is so abnormal that its monetary policy is distorting the foreign exchange market. That is the worst thing a central bank can do. If a central bank's monetary policy has distorted the exchange rate, it is not only natural but obligatory to restore it to normal.

 

 

The above is a quote from the Toyo Keizai Online article, but the normalization of the Bank of Japan's monetary policy will not be enough.

 

I would like to add that in order to offset the risk of economic recession from a sharp rise in interest rates, it is necessary to prepare in advance a policy mix that includes a permanent reduction in the consumption tax rate to 5% with the aim of abolishing the consumption tax.

 

 

 

Tomo Nakamaru

Former World Bank Economist