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 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