November 2023 Monthly: Aim for a virtuous cycle of
consumption and investment and the revival of Japan, with consumption tax
abolition and Bank of Japan interest rate hikes!
November
27, 2023
Issues with the Yomiuri 27th editorial, “Corporate
earnings are strong - it's time to accelerate wage increases and investment''
The Yomiuri Shimbun published an editorial in
its morning edition on November 27th titled, “Corporate financial results are
strong - it's time to accelerate wage increases and investment.'' However, it may not be free from serious
challenges.
It is true that this fiscal year's earnings
forecast is for a profit increase of more than 10% compared to the previous
year, but the industrial production and shipping index, which are normally
highly correlated with corporate performance, declined on year-on-year during the July-September period, even if
you look at the latest September statistics. The industrial slump has continued
for three consecutive months. In other words, the company's forecast for this
fiscal year is largely due to the yen's significant depreciation (a drop of
more than 10% against the dollar).
Furthermore, real GDP for the July-September
period fell into negative growth for the first time in three quarters compared
to the previous year, while the GDP deflator, which is known as comprehensive
inflation, showed domestic inflation of +5.1% compared to the same period last
year. To make matters worse, the twin engines of the Japanese economy, personal
consumption and corporate capital investment, have simultaneously fallen into
negative quarter-on-quarter declines for two consecutive quarters.
With signs of stagflation, such as inflation
and negative economic growth, already visible in the July-September period, the
government and the Bank of Japan implemented twin radical measures to stimulate
aggregate demand, consisting of a monetary policy of a different dimension and
a large-scale fiscal policy. In fact, it could accelerate inflation and further
amplify asset bubbles in stocks, real estate, foreign exchange, etc.
In the first place, wage increases and
capital investment are determined endogenously within the economy as a whole by
private actors.
The government and the Bank of Japan must aim
for price stability and sustainable economic growth by using fiscal and
monetary policies that are within their control.
Therefore, amidst the vicious cycle of
persistently high prices and the twin engines of consumption and investment in
the Japanese economy, on the one hand we have to hurry up the normalization of
monetary policy, and on the other hand we have to try to offset the negative
effects of the inevitable rise in interest rates as a side effect. We should hurry to permanently reduce the
consumption tax rate to 5% in order to abolish the consumption tax eventually.
Rather than relying on a temporary weak yen
to advocate wage increases and accelerating investment, which can only be
described as empty-handed, the fiscal and monetary policies of the government
and the Bank of Japan should be based on objective and scientific economic
logic.
Furthermore, the editorial’s claim that the
Japanese economy has not yet overcome deflation is exactly the same as that of
the government and the ruling party, but it cannot escape severe criticism as
clearly a deception.
This is because deflation refers to a
downward trend in prices and is not synonymous with a recession. A trending
rise in prices is inflation, and the current Japanese economy is experiencing
inflation due to high prices, so deflation can never exist.
However, inflation and recession can coexist.
This is nothing but the tragic stagflation, which is the worst state of the
economy (high prices and rising unemployment).
If the lie beats the truth
Coincidentally, on the 26th, the Tokyo Shimbun newspaper published a
truly persuasive and interesting article titled ``Think at the beginning of the
week: What if a lie beats the truth?''
According to the editorial, American author Mark Twain once said,
“While the truth is wearing shoes, a lie travels halfway around the world.''
In addition, there is an old Chinese proverb that goes, “A good deed
never leaves the gate, but a bad deed travels a thousand miles,'' which means
that it is difficult to spread the word about someone's good deeds, but a bad
story spreads quickly. ).''
The editorial added, “This is not just a
story about Mr. Trump, the election, or the United States. Lies and fakes will continue to be produced in all areas. We have no
choice but to continue to fight against these enemies by further nourishing
ourselves."
However, if you think about it, blatant lies are probably the most
prevalent under our country's political and economic system.
The biggest worry for the general public in Japan right now is the
hardship of living due to rising prices, which can be called a cost of living
crisis, or the pain of inflation taxes.
In fact, as a concrete indicator of the price stability target, the
core CPI excluding fresh food, which the government and the Bank of Japan have
been promising the people for the past 10 years, has already recorded a 3%
increase in fiscal 2022. Doesn't 3% exceed 2%?
Furthermore, core consumer prices excluding fresh food and energy
have not been affected by price declines due to government subsidies for
electricity, gas, and gasoline-related businesses; It has recorded an increase
of +4.0% year-on-year for consecutive months, reaching twice the Bank of
Japan's 2% price stability target.
Furthermore, regarding the future outlook for inflation, which is
more important, in its Price Outlook Report released at the end of October, the
Bank of Japan itself predicted that the core CPI, which is its price stability
target, would exceed 2% in FY23 and FY2024, in which
the central bank has even revised their views upward.
Despite this, the Kishida administration has made strong statements
such as “aiming for wages that can keep up with rising prices'' and “ensuring
an escape from deflation,'' and has implemented a large-scale supplementary
budget that exceeds 2% of GDP. We are
about to adopt such an extravagant fiscal stimulus package.
On the other hand, Bank of Japan Governor Ueda said that, given the
fact that the GDP deflator, which represents overall inflation for the Japanese
economy independent of import inflation, rose by 5.1% in the July-September
quarter from a year-on-year increase of 3.5% in the April-June quarter, the
Japanese economy needs to continue its monetary easing policy, which includes
negative policy interest rates, on the grounds that underlying inflation has
fallen short of the 2% price stability target.
In other words, while inflation has clearly exceeded 2%, both Prime
Minister Kishida and Governor Ueda have been trumpeting the lie that 2%
inflation has not been achieved, and are trying to reduce inflation through
aggressive fiscal and monetary policies, respectively. We cannot help but see this as an attempt to
continue and amplify excessive policies that stimulate aggregate demand, which
could further destabilize the state of the Japanese economy.
“Good prevails over evil, justice over injustice, and truth over
lies.'' If we lose this foundation, there will be no building called “society''
that can stand on it.” concludes the Tokyo Shimbun newspaper editorial.
It is truly regrettable that due to the lies about the soaring
prices that our country is facing, the acceleration of inflation in Japan and
the further amplification of asset bubbles will become uncontrollable, and I
cannot help but fear that Japanese society will collapse without a trace.
Breaking
with Abenomics, which is causing the crisis of rising living costs
What should we
do to prevent our country from completely collapsing?
Once again, we
may be able to find some light in the Tokyo Shimbun editorial dated November
22nd, similar to this subheading.
“Parliamentary deliberations have begun on the supplementary budget
bill for fiscal year 2023, which will be the source of funds for new economic
measures. The biggest issue is whether
the measures will help support people suffering from high prices, but the tax
cuts that are the centerpiece of the measures are unlikely to have an immediate
effect.
Questions remain. We must not hesitate to make major revisions to
create more effective countermeasures.
... Households and small and medium-sized businesses will fall
victim to high prices, while only some large companies will benefit. The
purpose of economic measures is supposed to be to improve the distorted
situation, but it can hardly be said that they hit the mark.
The main feature, income tax and resident tax reductions, will not
be implemented until June next year, and depending on the administrative work,
there is a possibility that there will be a significant delay.
Immediate effect should be given top priority for tax cuts to
stimulate consumption and support household finances, and the timing of this
tax cut is difficult to understand.
The supplementary budget, which totals approximately 13.1992
trillion yen, will be financed by government bonds, with 67%, or approximately
8.8 trillion yen, coming from government bonds. Tax reduction funding is
outside the scope of this amendment, and is expected to be raised through
increased issuance of government bonds in fiscal 2024. Before we knew it, the
return of increased tax revenue was replaced by increased issuance of
government bonds.
The economic policy”Abenomics'' led by the late Prime Minister
Shinzo Abe, which is centered on “bold monetary policy'' and “flexible fiscal
spending,'' is still being followed.
Although this has brought benefits to some, it has led to an
excessive depreciation of the yen, soaring energy costs, and rising prices of
goods, making household finances increasingly difficult. According to a survey
by the Ministry of Internal Affairs and Communications, the Engel coefficient,
which measures the proportion of food expenditures in consumption, exceeded a
monthly average of 26% from January to September, exceeding the comparable
average since 2000. The negative effects of Abenomics are becoming clearer,
with the Bank of Japan's underwriting of government bonds via banks leading to
unrestrained fiscal stimulus.
Prime Minister Fumio Kishida should decide to break away from
Abenomics. We must put an end to distorted economic policies that allow a few
large corporations to enrich themselves at the expense of people's livelihoods
and fiscal discipline. ”
The above Tokyo Shimbun editorial dated 22nd is extremely
persuasive.
So, what can we do to put an end to distorted economic policies,
establish optimal economic policies, and achieve sustainable, comprehensive
economic growth without inflation?
The only way to curb high inflation is to proceed with the
normalization of monetary policy. It is self-evident that we cannot continue
providing fiscal support, such as subsidies and handouts, to deal with
non-temporary price increases forever.
At the same time, in order to achieve comprehensive and sustainable
economic growth and reduce the side effect of economic recession caused by a
considerable rise in interest rates, which seems inevitable as monetary policy
normalization progresses, it is necessary to eliminate the consumption tax. A
permanent reduction in the consumption tax rate to 5% is seen as essential step
towards the abolishment.
Therefore, below, I will explain the significance of the policy mix
of normalizing monetary policy and permanently lowering the consumption tax
rate to 5% with the aim of abolishing the consumption tax, based not only on
the concept but also on the actual economic reality, using numerical values as
much as possible. Let's show it explicitly.
First, we will discuss the normalization of monetary policy, and
then examine the effects of a permanent sharp reduction in the consumption tax
rate toward the abolition of the consumption tax.
Easily calculate the policy interest rate using the
Taylor rule with Bing (Reprinted from August 29th Weekly)
(Nakamaru)
There is a famous Taylor rule for determining the level at which the policy
interest rate should be. What exactly is that rules-based monetary policy?
Then, use the latest economic data to estimate the current policy interest rate
levels of the Fed, ECB, and Bank of Japan.
(Bing)
The Taylor rule is an equation proposed by American economist John Brian Taylor
in 1993 to determine the appropriate policy interest rate based on the real
interest rate, inflation rate, and output gap. Specifically, it is expressed by
the following formula:
it=rt∗+πt+0.5(πt−πt∗)+0.5(yt−yt∗)
where it
is the policy interest rate, rt∗ is the equilibrium real interest rate,
πt is the inflation rate, πt∗ is the target inflation rate, yt is
the natural logarithm of actual gross domestic product (GDP), and yt∗
is the natural logarithm of potential output. is. This formula indicates
whether to raise or lower the policy interest rate if the inflation rate
deviates from the target value or if the output gap deviates from the
equilibrium value.
Using
the latest economic data, we will estimate the current policy interest rate
levels of the Fed, ECB, and Bank of Japan. The following values were used.
Item FRB
ECB Bank of Japan
Policy
interest rate (%) 4.25-4.50 5.00 0.00-0.10
Equilibrium
real interest rate (%) 2.00 2.00 1.00
Inflation
rate (%) 5.3 5.3 0.6
Target
inflation rate (%) 2.0 2.0 2.0
Actual
GDP (trillion dollars/trillion euros/trillion yen) 22.7 14.9 5.6
Potential
GDP (trillion dollars/trillion euros/trillion yen) 23.1 15.1 5.7
Substituting
these values into the Taylor rule expression yields:
iFRB=2+5.3+0.5(5.3−2)+0.5(ln(22.7)−ln(23.1))≈6.8
iECB=2+5.3+0.5(5.3−2)+0.5(ln(14.9)−ln(15.1))≈6.8
i Bank
of Japan=1+0.6+0.5(0.6−2)+0.5(ln(5.6)−ln(5.7))≈−0.1
Based
on the above results, it can be said that, based on the Taylor rule, the
Federal Reserve and the ECB should raise their policy interest rates by about 2
points from the current level, and the Bank of Japan should maintain their
policy interest rates at roughly the same level as now. However, it should be
noted that the Taylor Rule is only a reference indicator, and other factors are
also taken into consideration in actual monetary policy decisions.
(Nakamaru) Thank you. Try adjusting the
economic data and recalculating just the Fed and the Bank of Japan as follows.
The US inflation rate was 3.2%, and the Japanese inflation rate was 3.3%.
By
the way, the inflation rates in Japan and the United States have already
reversed. Data for July 2023...
(Bing)
Okay. Let's correct the US inflation rate and Japan's inflation rate and
recalculate the Fed and Bank of Japan's policy interest rates. It will be as
follows.
iFRB=2+3.2+0.5(3.2−2)+0.5(ln(22.7)−ln(23.1))≈4.7
i Bank
of Japan=1+3.3+0.5(3.3−2)+0.5(ln(5.6)−ln(5.7))≈1.9
Based
on these results, we can say that the Fed should lower its policy interest rate
by about 0.2 percentage points from the current level, and the Bank of Japan
should raise its policy interest rate by about 1.8 percentage points from the
current level. However, it should be noted that this is a simple calculation
based on the Taylor rule, and other factors are also considered in actual
monetary policy decisions.
By
the way, as you said, the inflation rates in Japan and the US will reverse in
July 2023. According to the IMF's July 2023 revised World Economic Outlook, the
US inflation rate will be 3.2% compared to the same month last year in July
2023, and Japan's inflation rate will be 3.3%. This is likely due to the
decline in demand and supply shortages caused by the coronavirus pandemic.
According to the indicators published by the Bank of Japan to capture the
underlying inflation rate, all core indicators excluding fresh food and energy
also recorded their highest rate of increase in July2. Whether such high
inflation will continue will depend on future economic conditions and policy
responses.
(Nakamaru)
Thank you. Next, modify as below and try again to find the ideal policy
interest rate based on the Taylor rule of the Fed and the Bank of Japan. The US
(core) inflation rate is +4.7% year-on-year, and the Japanese (core-core)
inflation rate is +4.3% year-on-year.
(Bing)
You're welcome. Let's recalculate the Fed and Bank of Japan's policy interest
rates. If we correct the US (core) inflation rate to 4.7% and Japan's
(core-core) inflation rate to 4.3%, we get:
iFRB=2+4.7+0.5(4.7−2)+0.5(ln(22.7)−ln(23.1))≈6.2
i Bank
of Japan=1+4.3+0.5(4.3−2)+0.5(ln(5.6)−ln(5.7))≈2.9
Based
on these results, we can say that the Federal Reserve should raise its policy
interest rate by about 0.75 points from the current level, and the Bank of
Japan should raise its policy interest rate by about 3.0 points from the
current level. However, it should be noted that this is a simple calculation
based on the Taylor rule, and other factors are also considered in actual
monetary policy decisions.
The FRB regains confidence on
a rules-based basis, while the discretionary Bank of Japan loses international
credibility (Reprinted from August 29th Weekly)
(Nakamaru) In any case, the current upper limit of the Fed's policy
interest rate is 5.5%, and the real policy interest rate adjusted for the 3% to
4% inflation rate has turned considerably positive.
However, the Bank of Japan's policy interest rate remains negative
at -0.1%, and the Bank of Japan's real policy rate, which allowed the Japanese
and US inflation rates to reverse, is extremely pro-inflation at -3 to -4%.
This could further amplify the inflation and the bubble.
In order to stabilize prices, the Bank of Japan will sooner or later
need to move real interest rates into positive territory on a par with the Fed,
and assuming rising inflation, the policy interest rate will not exceed 4% in
nominal terms, and it could even lead to a sudden reversal of the difference in
the level of the nominal policy interest rate.
This is the basis for believing that Japan's biggest post-war
economic crisis is approaching.
In any case, in a sense, the monetary policies of Japan and the
United States can be said to be at the extremes of each other.
On the one hand, the Fed has a rule-based monetary policy, and on
the other hand, the Bank of Japan has a discretionary monetary policy. Its
reliability appears to be increasing in the former, and decreasing and wavering
in the latter.
For the Bank of Japan, which is supposed to be the guardian of
prices and the currency, the Jackson Hole FRB seminar is a perfect opportunity
to suppress domestic supporters of continuing monetary easing, including
reflationalists, on the grounds of "external pressure" in order to
normalize monetary policy. How long will
Bank of Japan Governor Ueda, who seems to have missed this golden opportunity,
continue to be the government's watchdog?
Am I the only one who wishes that he would show some of his pride as a
former dean of the Faculty of Economics at the University of Tokyo?
Unfortunately, unless the BOJ makes a sudden change, it has no
choice but to allow inflation and asset bubbles to further amplify.
Samuelson's classic
consumption and investment circulation model using multipliers and acceleration
coefficients: Easy to construct for the Japanese economy using Excel!
The late MIT economics professor Paul Samuelson, who was the first
American to win the Nobel Prize in economics, published a textbook for
economics students titled "Economics," which was popular not only in
the United States but also at least during my time as a student at Hitotsubashi
University's economics department (1974 to 1978), it was quite famous not only
in Japan but also around the world. In
particular, Samuelson's cycle model of consumption and business investment is
widely known as a classic application model of the multiplier/acceleration
principle.
Coincidentally, as mentioned above, not only did Japan's GDP for the
July-September period of 2023 experience negative quarter on quarter growth in
real terms for the first time in three quarters, but both personal consumption
and corporate capital investment decreased compared to the previous quarter. It
has fallen into negative territory for the second consecutive period.
Therefore, I wondered if it would be possible to easily explain this
seemingly vicious cycle of consumption and investment using Samuelson's model
based on the multiplier and acceleration principles.
In any case, the multiplier/acceleration model is a classic model
that attempts to explain business cycles by combining the multiplier principle
regarding consumption and the acceleration principle regarding corporate
capital investment. Below, I will show an example of my application using a
classical model that was already constructed about 90 years ago.
In this model, income (Y) is expressed as the sum of consumption
(C), investment (I), and government spending (G).
Yt=Ct+It+Gt
Note that t is a subscript indicating time. For example, if it is
annual data, instead of t, consider the current year 2023.
Next, assume that consumption depends on disposable income one
period before.
C t= c(Yt-1-Tt-1)
Note, however, c: Propensity to consume is assumed to be constant.
Specifically, let's use 60%, which is consistent with the Japanese economy.
Therefore, in this model, consumption increases by 60% of the previous period's
disposable income, which is calculated by excluding consumption tax from
income. It is assumed that consumption tax (T) is determined by multiplying
consumption by the consumption tax rate.
Next, assume that a business fixed investment is determined by the
acceleration principle as follows. That is,
I t = v(C t-1- C_t-2)+It-1
Note, however, v: is the acceleration coefficient and is constant,
specifically 15%. In other words, in this capital investment model, investment
increases by 15% in proportion to the change in consumption from the previous
period, in addition to the level of investment from the previous period.
Furthermore, let's assume that government spending (G) is constant.
In addition, in the Excel chart shown below, Y (=GDP) in 2024 is the
nominal GDP level of 588 trillion yen for the July-September period of 2023, C
is the personal consumption level of the same period of 319 trillion yen, and I
use figures that are close to the actual Japanese economy, such as 99 trillion
yen for corporate capital investment during the same period, and 153 trillion
yen for G, the sum of government consumption and its investment for the same
period.
In this way, if you give the numbers for C, I, G, etc. for the
July-September period of 2023 as the same as those for 2023, you can use Excel
to calculate the income (=GDP), consumption, investments, etc. for next year
2024 and beyond. You can simulate the trends of investments, etc. The forecast
period in the Excel chart is up to 2030.
Simulation of a virtuous
cycle of consumption and investment and the revival of Japan with the abolition
of consumption tax
The results of applied simulations of Samuelson's classic
multiplier/acceleration coefficient model are illustrated at the end, but the
main points they show are as follows.
First, assuming a 10% consumption tax rate, almost zero growth until
2030 seems inevitable. In a sense, this is a natural result, since 10% of
consumption is deducted from income as consumption tax, and disposable income
stagnates.
Second, currently, in addition to the 10% consumption tax, there is
an inflation tax of approximately 4%, effectively raising the consumption tax
to a combined consumption tax rate of 14%. Due to this double whammy, the
Japanese economy could fall into negative growth until 2030. This is a case of
a vicious cycle of consumption and investment.
Third, if the consumption tax rate is permanently lowered to 5%,
Japan's economy appears to be able to achieve sustained positive growth.
Finally, if the consumption tax were abolished, the Japanese economy
would be able to achieve sustained and considerably high growth. This can be
said to be a case in which a virtuous cycle of consumption and investment is
created by avoiding a decrease in disposable income due to the abolition of the
consumption tax.
In short, we must put an end to the distorted and endless economic
policy of the late Prime Minister Shinzo Abe's economic policy “Abenomics,''
which was based on “bold monetary policy'' and “flexible fiscal stimulus'' that
assumed a deflationary recession. This is crucial in times of crisis due to
rising costs of living amid inflation.
In order to achieve sustainable and comprehensive economic growth without inflation, it is important to establish optimal monetary and fiscal economic policies and implement an appropriate policy mix, as shown in the diagram below.
The only way to curb high inflation is to proceed with the
normalization of monetary policy. It is self-evident that we cannot continue
providing fiscal support, such as subsidies and handouts, to deal with
non-temporary price increases forever.
At the same time, in order to avoid the risk of an unavoidable rise
in interest rates as monetary policy normalizes and to achieve sustainable and
inclusive economic growth, it is necessary to permanently reduce the
consumption tax to 5% in order to achieve sustainable and comprehensive
economic growth.
Conversely, amid the double whammy of a 10% consumption tax rate and
a high inflation tax of about 4%, a vicious cycle of consumption and investment
and signs of stagflation are already occurring, and a virtuous cycle of wages
and prices is only a mirage. It is important
to keep in mind that beautiful words are nothing more than pictures.
Former World Bank Economist
Tomo Nakamaru
Appendix: Simulation of the Japanese
economy applying the consumption/investment cycle Samuelson model using
consumption multiplier and investment acceleration coefficient; 4 cases
