This week's weekly: Japan's economic policy facing chaotic dismantling

 

This week's weekly: Japan's economic policy facing chaotic dismantling

 

 

November 13, 2023

 

Postponing dissolution within the year, focusing on policies for the people

 

I was encouraged by the Asahi Shimbun editorial published on November 12, the first Sunday of this week, with a title similar to the subheading above, and the following persuasive argument.

 

“Prime Minister Kishida, who has been exploring opportunities to dissolve the House of Representatives, including during the recent ordinary session of the Diet, has decided to hold off until the end of the year.　Even if he reshuffles his cabinet and proposes economic measures, including income tax cuts, his approval rating has not recovered. This decision was made after being forced into a difficult situation due to the schedule.　It is nothing but his own fault.''

 

In addition, the editorial states, “The current term of office for members of the House of Representatives finally reached the halfway point of two years last month.　Furthermore, the ruling party has secured a far greater number of seats than the opposition parties in both houses of the House of Representatives, has been waiting for an opportunity to dissolve the party, probably because they want to win the House of Representatives election and secure re-election before the Liberal Democratic Party presidential election next fall. However, they have not made any preparations for dissolution, everything is backfiring."

 

As a specific reason for this, the same editorial states, “The necessity and effectiveness of the fixed-rate tax cuts for income and resident taxes, which the prime minister has led as a pillar of economic measures, are being questioned, and the public's reception is lukewarm.  It is no wonder that Japan's finances depend on debt and that they are refraining from increasing the burden of increasing defense spending and funding measures to address the declining birthrate.”  After all, the starting point for the prime minister's decisions is his self-interest.  It is clearly seen as a matter of maintaining his own power through the re-election of the president, rather than the people, is the reason why his approval rating, which has fallen to the lowest level since the inauguration of the government, is not easily reversed.''

 

Indeed, the editorial says, “Except in cases where the Cabinet aims to change important policies by pointing out the harmful effects of the arbitrary use of the right to dissolve, it is recommended that members of the House of Representatives serve their full term and work diligently. There is no doubt that this is true.”

 

“After the new year, the Prime Minister will continue to look for opportunities to dissolve the Diet before the presidential election.'' 　A situation similar to the previous ordinary Diet session, where parliamentary deliberations were reduced to a formality due to the　”dissolution“ instigated by the Prime Minister, will be repeated. It must not be.

 

Recently, the prime minister has repeatedly stated that he is "dedicated to the government" in tackling various issues. As he said, he should not try to devise strategies, but should keep in mind that the only way forward is by putting the people first and making steady efforts.” The Asahi editorial is highly persuasive.

 

The vicious cycle of wage increases and prices

 

By the way, as I have repeatedly pointed out in the past Weekly, wages are determined by labor demand and supply, mainly depending upon labor productivity, between labor and management, and there is little room for government policy to be involved.

 

Moreover, when the government intervenes to raise wages amid rising prices, past cases in the East and West and in Japan have shown that rather than a virtuous cycle of wages and prices, it is more likely to lead to a vicious cycle.

 

Real wages have already begun to rise in the United States, but this is only because the Federal Reserve has been actively raising interest rates significantly and bringing down the inflation rate.

 

Amid soaring prices, Japan has continued to implement policies that stimulate excessive aggregate demand through both fiscal and monetary policies. Isn't it logical that inflation will never subside no matter how long it takes?

 

Therefore, for example, a tax system that promotes wage increases can be said to be bad government policy that can amplify the vicious cycle between wages and prices rather than the virtuous cycle between them, and economic policy may be overly interfering with individual companies on a microscopic level. Instead, it should be addressed through macro fiscal and monetary policies as a whole.

 

Japan's media should not be unnecessarily complicit in the “stories'' about the virtuous cycle of wages and prices, which remain nothing more than a “myth,'' and the government's fabricated stories that do not apply in Europe and the United States.

 

For example, once again, in the UK, wages and prices have fallen into a tit-for-tat strategy between labor and management, and while some point out a vicious cycle between them, no one points out a virtuous cycle. It's no exaggeration to say that.

 

In any case, as real wage increases are no longer a condition for the Bank of Japan to lift zero interest rates, Kishidanomics would have been removed from the ladder by Governor Ueda, as will be introduced in a later section, from the story of a virtuous cycle of wages and prices. The day may be approaching.

 

 

Bank of Japan Governor Ueda insists that it will be difficult to restore inflation rates that are lower than desired levels

 

In an interview with the world-renowned chief economist Martin Wolff in the Financial Times on November 9th, Bank of Japan Governor Ueda stated, “Japan's underlying inflation rate is still at 2. %," and secondly, “Although the Bank of Japan has made progress toward its goal, there is still some distance from it to 2%,'' the Blumberg article points out.

 

Also, according to the same article, the Bank of Japan governor indicated that he is in no hurry to normalize monetary policy, saying that given Japan's current situation, lower-than-desirable inflation is more difficult to deal with than overshooting.

 

More specifically, he said, “In the case of an overshoot, I think it can be dealt with by raising interest rates,'' and “In the case of an undershoot, the effective lower bound for interest rates is zero, and non-traditional, given the constraints and problems with monetary policy instruments, it will be quite difficult to address."

 

Mr. Ueda said the Bank of Japan is making progress toward its 2% inflation target. "We reiterated our view that we are not there yet," the Blumberg article continued.

 

He also said that raising interest rates will be a "serious challenge" for the Bank of Japan once an exit from ultra-accommodative policy is in sight, and that it must consider the impact on commercial banks, borrowers, and aggregate demand, he said.  Controlling long-term interest rates will also be a major issue. He said he hoped the BOJ could exit without causing big fluctuations in the bond market, but we'll see whether that happens.

 

Last week, the Bank of Japan decided to loosen the constraints on yield curve control (YCC, short- and long-term interest rate control) by positioning the 1% upper limit on 10-year government bond yields as a reference value rather than a strict upper limit. Economists view the move as a step toward normalization that avoids a spike in market volatility.

 

In addition, the same Blumberg article states, “Mr. Ueda recognized that there are challenges to ending negative interest rates, saying, “Everyone is used to a low interest rate environment, so we have to proceed very carefully.'' “Of course, we will carefully analyze how changes in exchange rates will affect inflation and production. We will take action if necessary.''

 

However, it is still a bit surprising to observe that Bank of Japan Governor Ueda has been so passive regarding the government's fiscal policy, and that he has shown no signs of actively engaging or making proposals regarding fiscal policy.

 

It is true that fiscal policy is a political process, and the final decision is not made by the central bank, but in Japan's case, the only way is for the government, represented by the ruling party, to make final decisions based on a parliamentary cabinet system.

 

Kishida administration decided to implement a fiscal stimulus policy for this fiscal year of about 2% of GDP, although the prices in Japan are rising about 4% year-on-year, and the aggregate demand of the Japanese economy already exceeds the aggregate supply albeit slightly.  The budget has already been approved by the Cabinet and it is about to be submitted to an extraordinary Diet session soon. 

 

It is difficult to understand the BOJ governor Ueda does not seem to be uneasy about such an extremely expansionary fiscal policy being initiated by the Kishida government, given the galloping rates of inflation in Japan. 

 

In response to the soaring prices that are currently becoming the biggest challenge for the lives of consumers and the general public, both fiscal and monetary policies continue to aim for large-scale aggregate demand stimulus measures to prevent inflation from overshooting. In short, BOJ Governor Ueda’s stance on undershooting of inflation is far removed from reality in Japan and must be harshly criticized as deceptive.

 

To begin with, the Japanese economy, which is riddled with many challenges, clearly cannot be controlled by the Bank of Japan's monetary policy alone.  In order to control the economy to achieve price stability and sustainable growth, it is essential that the Bank of Japan take an proactive and assertive stance not only in monetary policy but also in the government's fiscal policy.

 

If nothing else, given the “extraordinary fiscal expansion'' of Kishidanomics, which is straying, the core CPI excluding fresh food and energy will continue to exceed 4% year on year in FY2023, and the Ueda Bank of Japan seems to have already reached the point where inflation is out of control and Japan is now facing the worst economic crisis.

 

Unfortunately, under current Bank of Japan Governor Ueda, who, like Bank of Japan Governor Kuroda, belongs to the bubble cleanup camp, the asset bubble is likely to be further amplified, and it appears to be only a matter of time before the bubble finally explodes. .

 

 

Although the Bank of Japan has admitted that there was an error in its price forecast...

 

According to a Blumberg article that appears to be dated November 9, “Bank of Japan Governor Kazuo Ueda announced on the 8th to the House of Representatives Finance and Financial Services Committee his opinion that there was an error in the Bank of Japan's consumer price forecast, which has been repeatedly revised upward. He gave his answer at the meeting.''

 

The article continues, “Governor Ueda explained that the current rise in prices is due to two forces: the “first force” caused by the pass-on of import prices, and the “second force'' caused by the virtuous cycle of wages and prices. Although he predicted that the rate of increase in prices due to the former would decline, he said, “We have continued to make upward revisions,'' and “We have to admit that there was a mistake in our forecast.”

 

“On the other hand, we are not far off in our judgment that the latter is still weak.  There were no major mistakes in conducting monetary policy based on that aspect.'' He stated that the rise in prices pushed up by import prices will "sooner or later lose momentum," adding, "We are maintaining monetary easing in order to foster a second force."

 

In addition, “Although the Bank of Japan predicted in April that the rate of increase in consumer prices would slow down in positive territory by the middle of this fiscal year, it has remained at a high level exceeding the 2% target for the past year and a half.  The outlook was revised upward in April and October, with some pointing out the naivety of the forecast.  In his response today, Governor Ueda acknowledged some of the criticism, but said that the outlook for sustainable growth with wage increases and “This is a statement of the legitimacy of the current monetary policy, stating that the expected 2% rise in interest rates has not yet been achieved.''

 

Finally, “At its October 31st monetary policy meeting, the Bank of Japan decided on measures to make yield curve control (YCC) more flexible, allowing long-term interest rates to exceed the upper limit of 1%.  The same Bloomberg article pointed out, “We raised all consumer price outlooks for fiscal 2023 through fiscal 2025.''

 

Furthermore, Governor Ueda explained that when deciding whether to normalize monetary policy, it is not necessary that real wages are starting to rise, and that it is expected that real wages will turn positive amid a virtuous cycle of wages and prices. “The question is whether we can reach a state where we can have it with a certain degree of certainty,'' and “There are cases where it is positive, and there are also cases where it is just short of that,'' the same article reported.

 

Even if it is good to admit that a mistake was made, however, it must be said that the Governor has not yet corrected all of his mistakes.

 

Both the first force of imported inflation and the second force of domestic inflation (due to the circulation of wages and prices, etc.) are accelerating, and Governor Ueda's view is still far from correct.

 

It is true that prices such as crude oil have been on a downward trend recently, but the yen continues to depreciate, making it highly doubtful that import inflation (the first arrow) will come to an end.

 

Furthermore, regardless of whether there is a virtuous or vicious cycle between wages and prices, we cannot help but think that domestic inflation has been increasing.  For example, the core-core CPI, which excludes fresh food and energy, and therefore excludes (opaque) government subsidies to electricity, gas, and gasoline businesses, has already exceeded 4% from the previous year throughout this fiscal 2023.  Why aren't we talking about the fact that we have continued to record high inflation rates well beyond the BOJ’s 2% target?

 

There is no way that the Governor of the Bank of Japan does not know that the inflation rate is moving at about twice the Bank of Japan's price stability target of 2%.

 

In any case, it is disappointing to observe the Ueda Bank of Japan almost entirely arbitrary and subjective, and far removed from modern monetary policy, which is ruled based one with objective rules of fairness, transparency, and consistency.

 

Furthermore, the statement that “real wages do not necessarily need to start rising at the time of normalization judgment'' can be seen as arbitrary and contradictory to previous claims, which may adversely surprise the economy and shock the financial markets not in the far distant future.

 

El-Erian on FT: Major central banks should use timeouts wisely

 

On November 7th, El-Erian, a well-known investor and chancellor of Queen's University, Cambridge, published an article in the FT with the title, “Major central banks should use timeouts wisely'', roughly as follows:

 

"All four systemically important central banks (Bank of England, Bank of Japan, European Central Bank, and Federal Reserve) have effectively declared a 'timeout' on major policy actions over the past two weeks. In three out of four cases, using the timeout effectively was the right thing to do. All four central banks decided to keep interest rates on hold and left the door open to the possibility of a return to rate hikes in the future. ”

 

“The Bank of Japan, one of them, has also made some adjustments to its ”yield curve control'' policy, in which it purchases bonds to keep yields low. On the surface, all four central banks have had time to assess the impact of past actions and internalize more data. But what they need to do goes far beyond this. ”

 

"At the end of the day, while the data is broadly positive, the BoE, ECB and Fed still feel they need to properly understand the cumulative impact of aggressive rate hikes."

 

“The Bank of Japan is assessing the impact of allowing the 10-year government bond yield to move by almost 1 percentage point under a series of YCC adjustments. However, such a tactical framework is too narrow and will cause problems. There are strategic issues that require a more timely response.…”

 

“Is this the tipping point for interest rates? The BOJ needs to think about timeouts in the most comprehensive way, especially as the market loses patience with what it sees as an overly cautious exit from the YCC.”

 

“Recent policy announcements have stimulated both rising yields and a weaker yen, a combination that once again forces central banks to buy bonds and threatens foreign exchange intervention. Rather than stopping the clock, this timeout may have inadvertently accelerated the decline at a time when exits from the system have been lagging behind markets. posed a counterproductive risk to the country and is now subject to unregulated demolition.”

 

“For two years, the world's major central banks have mistakenly declared a timeout on inflation, which has proven detrimental to economic and fiscal health and hit the most vulnerable segments of the population particularly hard. A frantic catch-up process that followed allowed the three to declare time-out again, this time from a stronger position. We hope to strengthen our outlook and, in the process, strengthen our defenses against the growing risk of negative impacts from Japan's messy withdrawal from the YCC program, with an avalanche of bond issuance expected in several countries.”

 

Unfortunately, not only in Japan, which is weak and obedient to authority, but in G7 developed countries such as the United States and the United Kingdom, it is safe to say that the credibility of the Bank of Japan has already been significantly diminished or even questioned.

 

In the end, the Ueda Bank of Japan may be able to deceive Japan, but the world may not be deceived.

 

When I was a World Bank economist (Turkey and Pakistan), Mr. El-Erian was the IMF's Turkey and Pakistan regional manager, which is located just across 18th Avenue from the World Bank in Washington, DC.   I have no doubt that he is a very talented person.

 

As the American-based Blumberg reported, there was no domestic media that criticized Nikkei's preliminary report on the second YCC tweak, and the fact that the BBC's issue of Johnny & Associates' sexual abuse of minors was not seen as a problem by the Japanese media. As a developed country known as the fourth power, Japan's media is likely to be criticized, at least by the G7 developed countries, for abdicating its responsibility.

 

In any case, what exactly do Governor Ueda and Prime Minister Kishida plan to do with the Japanese economy, which is clearly at mess?

 

 

The see-saw game between bulls and bears is in full swing amid the fear of year-end greed and interest rate hikes resuming!

 

In the US financial markets last weekend, year-end greed outweighed fears of a reacceleration of inflation expectations, but the sustainability of this trend is uncertain.

 

That's at least partly because the University of Michigan's inflation expectations announced last weekend rose from 4.0% in the previous month to 4.4% in November. Furthermore, inflation expectations for the next 5-10 years rose to 3.2% in November from 3.0% in the previous month. Long-term inflation expectations were at their highest level since 2011.

 

However, the U.S. financial market last weekend recorded an almost unilateral rise due to the rapid advance in high technology, with Microsoft in particular drawing attention to its highest price since going public, as if to say don't miss the year-end rally bus.

 

Bank of America strategist Michael Hartnett said the caution pervading the stock market over the past three months has given way to "year-end greed," according to a Bloomberg article. He says that expectations for lower U.S. bond yields are behind this.

 

This week, the US October CPI will be released on Tuesday. Concerns about a U.S. federal government shutdown may also resurface towards the weekend.

 

Although there is hope for price stability and sustainable growth in the US economy over the long term, we must remain cautious about short-term negative developments in the US political economy.

 

On the other hand, the Japanese economy. although the financial market has become greedy and complacent in the short term to an extent that surpasses that of the Heisei bubble, the continued endless stimulus measures of aggregate demand through the twin fiscal and monetary policies are expected to worsen inflation in the medium to long term.  Unfortunately, we must warn that there is an extremely high possibility that the asset bubble will spiral out of control.

 

 

 

Tomo Nakamaru

Former World Bank Economist