This week's weekly: A cat-and-mouse game of wage increases and inflation will not lead to a virtuous cycle of consumption and investment and a revival of Japan.

 

This week's weekly: A cat-and-mouse game of wage increases and inflation will not lead to a virtuous cycle of consumption and investment and a revival of Japan.

 

December 4, 2023

 

 

Let's review the consumption and investment cycle model using classical multipliers and acceleration coefficients.

 

In November Monthly, we introduced a cyclical model of personal consumption and corporate capital investment based on the multiplier/acceleration principle of the late Paul Samuelson, an MIT economics professor who was the first American to win the Nobel Prize in Economics.

 

Japan's GDP for the July-September period of 2023 not only experienced negative growth compared to the previous quarter for the first time in three quarters in real terms, but also personal consumption and corporate capital investment both fell negative compared to the previous quarter for the second consecutive quarter. This led me to wonder if Samuelson's model, based on the multiplier and acceleration principle, could be used to explain what appears to be a vicious cycle of consumption and investment.

 

In this week's Weekly, let's first review Samuelson's classic cyclical model of consumption and investment.

 

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)

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 company's capital investment is determined by the acceleration principle as follows. That is,

I t = v(C t-1- Ct-2)+It-1

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 order to increase the reality of the model, Y (=GDP) in 2024 is the nominal GDP level for the July-September period of 2023, which is 588 trillion yen, and C is the personal consumption level for the same period, which is 319 trillion yen.  I is corporate capital investment of 99 trillion yen for the same period, G is 153 trillion yen, which is the sum of government consumption and government investment for the same period, etc.

 

In this way, if we assume that the figures for C, I, G, etc. for the July-September period of 2023 are the same as those for 2023 and feed them into Excel, we can calculate the income (=GDP), consumption, etc. for next year 2024 and beyond. It was said that it was possible to simulate the trends of investments, etc.

 

 

Abolition of consumption tax will enable a virtuous cycle of consumption and investment and the revival of Japan.

 

In the Monthly, we attempted a simulation assuming four cases, but in this Weekly, we will first focus on the vicious cycle of consumption and investment among those four cases. In this vicious cycle, in addition to the current 10% consumption tax rate, an inflation tax of about 4% has effectively raised the consumption tax to a total of 14%, and these consumption taxes It is simulated that the Japanese economy could fall into negative growth until 2030 due to the double whammy of inflation tax and inflation tax. This can be said to be the worst case scenario of a vicious cycle of consumption and investment. Next, it is simulated that 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 the best case for creating a virtuous cycle of consumption and investment by largely avoiding a decline in disposable income through the abolition of the consumption tax.

 

In other words, 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 of crucial importance in times of crisis due to rising costs of living amid inflation.

 

 

The policy mix for Japan's revival is consumption tax elimination and Bank of Japan interest rate hike!

 

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 financial 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. At the very least, a reduction in the consumption tax rate will be essential.

 

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 being created. It is also extremely important to keep in mind that beautiful words are nothing more than pictures.

 

The Yomiuri editorial dated December 4th, “Pass-on of labor costs is essential for raising wages for small and medium-sized enterprises'' is a fallacy.

 

This morning's Yomiuri editorial titled is not without problems.  Therefore, I asked Google Bird.

 

(Nakamaru) This morning's Yomiuri editorial features an editorial titled “Pass-on of labor costs is essential for raising wages at small and medium-sized enterprises.''

 

However, it is common knowledge in Western economics that rising wages and prices become a vicious rather than a virtuous cycle, potentially leading to an uncontrollable inflationary spiral.

 

In fact, Japan's real GDP growth rate for the July-September quarter fell into negative growth compared to the previous quarter for the first time in three quarters, but as inflation accelerated, both personal consumption and corporate capital investment fell into negative growth for the second consecutive quarters, causing economic decline. Consumption and investment, which should have been a twin engine, are sluggish, and both are falling into a vicious cycle.

 

Additionally, the October unemployment rate fell (improved) to a historically low level of 2.5%, and supply and demand in Japan's labor market remains tight.

 

Furthermore, the government and the Bank of Japan continue to carry out massive fiscal stimulus and unprecedented monetary easing.

 

As the paper argues, amid overheating inflation in the Japanese economy and amplification of asset bubbles in stocks, real estate, etc., the reason for insisting that small and medium-sized enterprises should shift labor costs is to control both inflation and asset bubbles in the Japanese economy seems to be at least shaky.  Isn't it necessary to say that the risk of making it impossible is extremely high?

 

(Bard) As you pointed out, it is common knowledge in Western economics that rising wages and prices create a vicious rather than a virtuous cycle, potentially leading to an uncontrollable inflationary spiral.

 

The Yomiuri editorial argues that it is essential to pass on labor costs to encourage small and medium-sized enterprises to raise wages. However, passing on labor costs may put pressure on corporate profits and lead to further price increases due to price passing on. If this happens, there is a risk that the economy will fall into a vicious cycle of rising wages, rising prices, rising wages, rising prices, and so on, accelerating the inflationary spiral.

 

Furthermore, the Japanese economy is already in a situation where inflation is overheating and asset bubbles such as stocks and real estate are amplifying. If small and medium-sized enterprises are encouraged to pass on labor costs, this could lead to further inflation and the expansion of asset bubbles, which could undermine economic stability.

 

Therefore, the Yomiuri editorial's claims can be said to be highly risky considering the current state of the Japanese economy.

 

Specifically, you need to pay attention to the following points.

• Wage increases at small and medium-sized enterprises may put pressure on corporate profits and put pressure on management.

• Passing on labor costs to prices may lead to further price increases.

• The Japanese economy is already in a situation where inflation is overheating and asset bubbles are amplifying.

In order to avoid these risks, it is necessary to consider the following points.

• Wage increases for small and medium-sized enterprises must be done within a range that does not put pressure on the company's profits.

• Passing on labor costs must be done carefully to avoid further price increases due to price passing on.

• Governments need to take steps to curb inflation and combat asset bubbles.

Specifically, the government is required to take steps to curb inflation and combat asset bubbles through measures such as normalizing monetary policy and reviewing fiscal policy. It is also important to create an environment that promotes wage increases through improvements in labor-management relations and management support for small and medium-sized enterprises.

 

 

Supplementary budget passed, full of problems, still uncorrected

 

On the other hand, the Asahi Shimbun made this argument in an editorial dated November 30th, as shown in the main subheading, and it was quite persuasive, so I will reproduce the opening and conclusion sections below.

 

“The scale of the bloated expenditures and the content of each item are full of questions, and a supplementary budget was passed in which 70% of the financial resources depended on debt. The problems could not be corrected through routine, short-term deliberations, and confidence in the Diet as a whole was lost.

 

During the question-and-answer session of the House of Representatives Budget Committee on three days each, Prime Minister Kishida and others did not provide a convincing explanation until the end. When asked the fundamental question of whether the current economic situation requires fiscal stimulus of more than 13 trillion yen, comparable to what was seen after the Great East Japan Earthquake, the government gave only abstract answers such as “the result of accumulating necessary policies.''

 

The Finance Act limits the supplementary budget to "essential expenses." While it is understandable to provide handouts to low-income people who are suffering from high prices right now, it is contrary to the purpose of the government to spend trillions of yen on increasing funds to support industry and continuing public works projects.  However, the government repeatedly insisted that these measures were "urgent."

 

Although not included in this amendment, the fixed tax cut for next fiscal year proposed by the prime minister was also a major point of contention. What is the policy purpose? Is it consistent with the defense tax increase? Why is the government insisting on tax cuts that have no immediate effect? The prime minister did not give satisfactory answers to the numerous questions posed by the opposition parties.

 

Under these circumstances, there is no hope that the public's understanding of economic measures or trust in the Cabinet will recover.  At the root of the prime minister's decisions is his desire to maintain his own power and to prepare for elections. The prime minister should take the fact that such suspicions are being focused on him seriously. …”

 

“...The Constitutional Democratic Party of Japan, the largest opposition party, is partly to blame for the failure of the opposition party to fulfill its role. It is not possible to call for thorough deliberations that are not conventional and to present the issues more clearly to the people.”

 

 

The British Economist magazine “Japan: A Chance to Rise Again” dated November 16th is deja vu

 

(Nakamaru) By the way, what was the November 16th edition of the British Economist magazine's "Japan: A Chance to Rise Again" about, and how has it been received since then?

 

(Bard) The “Japan: A Chance to Rise Again'' feature in the British magazine The Economist on November 16th is about the re-emergence of the Japanese economy. The special feature points out factors such as a declining birthrate and aging population, deflation, and budget deficits as factors that have kept Japan's economy stagnant for many years.  In order to overcome these issues, it is necessary to promote digitalization, regulatory reform, and flexibilization of the labor market. argues that reform is necessary.

 

The special feature makes the following recommendations as specific reform proposals.

• Promoting digitalization: Improving productivity by moving administrative procedures online and utilizing AI, robots, etc.

• Regulatory reform: improving the business environment and promoting the introduction of new technology

• Flexibility of the labor market: diversification of employment forms, shorter working hours

Reception of the special feature was generally positive. The special feature, which emphasizes the need for reform as Japan's economy has continued to stagnate for many years, seems to have resonated with many Japanese people.

 

Specifically, the evaluation is as follows.

• Accurately understands the current situation of Japan's economic problems and presents solutions.

• The content that calls for the need for reform is persuasive.

• Gives hope for Japan's economic revitalization

 

On the other hand, the following criticisms were also seen.

• Some of the specific details of the reforms are unlikely to be realized.

• Political leadership is needed to promote reform, but the current administration's stance is questionable.

In any case, it can be said that this special issue has served as an opportunity to revitalize discussions toward the re-emergence of the Japanese economy.

 

There are pros and cons to specific reform proposals. For example, regarding the promotion of digitalization, there seem to be many positive opinions, saying that moving administrative procedures online and using AI and robots will lead to improved productivity and work style reform.

 

On the other hand, regarding regulatory reform, improving the business environment and promoting the introduction of new technology is expected to be a driving force for economic growth, but there are concerns about the impact on existing industries and workers.

 

Regarding the flexibilization of the labor market, there seem to be many positive opinions, saying that diversifying employment forms and shortening working hours will lead to easier work and improved quality of life for workers. On the other hand, there are concerns about rising labor costs and declining productivity.

 

In this way, it is necessary to carefully consider the merits and demerits of each reform proposal, and political leadership and public understanding will be essential for its realization.

 

(Nakamaru) Wasn't there a special feature in the British newspaper The Economist about the continuing unconventional monetary easing centered on the Bank of Japan's negative policy interest rate, the historic depreciation of the yen, and endless fiscal disarray? ”

 

(Bard) No, it wasn't. The special feature emphasizes three points as reforms necessary for the re-emergence of the Japanese economy: promotion of digitalization, regulatory reform, and flexibilization of the labor market. These reforms all fundamentally change Japan's economic structure from a medium- to long-term perspective, and are distinct from short-term economic policies.

 

In the special feature, the Bank of Japan's monetary easing and fiscal policies are referred to as "necessary conditions" for the re-emergence of the Japanese economy. However, there is a view that these policies will not solve the fundamental problems of Japan's economy.

For example, the following points are made in the special feature article:

• The Bank of Japan's monetary easing has not been able to overcome deflation.

• Fiscal policy increases budget deficits and burdens future generations.

Therefore, the special feature positions these policies as merely "conditions" and argues that further reforms are necessary for the re-emergence of the Japanese economy.

 

Specifically, the special feature recommends the following reforms.

• Clarify the exit strategy for monetary easing.

• Develop a concrete plan to reduce the budget deficit.

All of these reforms require political leadership and public understanding, and will likely be difficult to implement. However, the special feature emphasizes that these reforms are essential for the reemergence of Japan's economy.

 

(Nakamaru) It was pointed out on TV Tokyo Morning Satellite this morning that the British newspaper The Economist had featured Japan at least twice in the past, but what kind of Japanese articles have the British newspaper The Economist actually written in the past? Was it something?

 

(Bard) The British newspaper The Economist has featured Japan at least twice in the past.

The first one is "Japan: The Sun Sets" dated January 2, 2012. The theme of this special feature is whether Japan can escape from the ``lost 20 years'' as Japan's economic stagnation worsens. The special feature points out the causes of Japan's economic stagnation, including a declining birthrate and aging population, deflation, and fiscal deficits, and argues that structural reforms are necessary to overcome these issues.

 

The second issue is “Japan: The Land of the Rising Sun is Setting” dated October 24, 2019. This special feature focuses on the situation where there are concerns that Japan may enter a "lost 30 years" as the Japanese economy continues to stagnate. The special feature once again points out the causes of Japan's economic stagnation, such as the declining birthrate and aging population, deflation, and fiscal deficits, and warns that drastic reforms are necessary to overcome these issues.

 

These special features all sharply point out Japan's economic problems and emphasize the need for reform. As a result, it attracted attention from Japan's business and political circles and caused a great response.

 

Specific evaluations include the following opinions.

• Accurately understands the current situation of Japan's economic problems and presents solutions.

• The content that calls for the need for reform is persuasive.

• Makes important points as a wake-up call for Japan's economic revitalization.

 

On the other hand, the following criticisms were also seen.

• The specific details of the reform are insufficient.

• Not fully understanding the complexity of Japan's economic problems.

In any case, it can be said that these special features have served as an opportunity to revitalize discussions toward the re-emergence of the Japanese economy.

The title "Japan: The Sun Sets" that was pointed out on TV Tokyo Morning Satellite is the title of the 2012 special feature. The title of the 2019 feature is “Japan: The Land of the Rising Sun is Setting.”

 

(Nakamaru) So, what are the characteristics of this year's Economist's Japan special feature compared to past ones? Is that reasonable?

 

(Bard) This year's special feature on Japan in The Economist magazine has the following three points.

1. Calls for fundamental reform of Japan's economic structure from a long-term perspective

In the past two special features, we have cited the declining birthrate and aging population, deflation, and fiscal deficits as causes of Japan's economic stagnation, and argued that structural reforms are necessary to overcome these issues. However, this year's special feature emphasizes the view that in order to overcome these challenges, it is necessary to fundamentally transform Japan's economic structure from a medium- to long-term perspective rather than short-term policies. It has been.

 

2. Recommends that reforms should focus on three points: digitalization, regulatory reform, and labor market flexibility.

This year's special feature recommends that reforms should focus on three points: digitalization, regulatory reform, and labor market flexibility. All of these reforms will fundamentally change Japan's economic structure, and will be difficult to implement. However, the special feature emphasizes that these reforms are essential for the re-emergence of Japan's economy.

 

3. Presents concrete reform proposals to re-emerge the Japanese economy

This year's special feature presents concrete reform proposals on three points: digitalization, regulatory reform, and labor market flexibility. For example, with regard to digitalization, we are proposing things like moving administrative procedures online and improving productivity through the use of AI and robots. Regarding regulatory reform, we propose improving the business environment and promoting the introduction of new technology. Regarding the flexibilization of the labor market, proposals include diversifying employment forms and shortening working hours.

 

These characteristics reflect the recognition that fundamental reforms are necessary in order for Japan to overcome the "lost 30 years" and reemerge as Japan's economic stagnation continues to prolong. You could say that.

 

There are pros and cons as to its validity. Those in favor will likely agree with the view that in order to re-emerge the Japanese economy, it is necessary to fundamentally reform Japan's economic structure from a medium- to long-term perspective. Opponents will argue that the three reforms - digitalization, regulatory reform and labor market flexibility - are unlikely to be implemented.

 

In any case, it can be said that this year's special feature on Japan in The Economist magazine has the potential to revitalize discussions on the re-emergence of the Japanese economy.

 

 

Keynes said, “In the long run, everyone will die.''

 

(Nakamaru) But aren't long-term "structural reforms" such as digitalization, regulatory reform, and labor market flexibility being proposed in much the same way over the past 30 years? For example, the Nikkei Shimbun has been advocating a structural reform policy for over 30 years. There was also the Koizumi structural reform.

 

By the way, Keynes was the greatest economist of the 20th century who advocated the importance of short-term macroeconomic policy, especially fiscal policy, stating that “in the long run, everyone dies.''

 

In the style of Keynes, who was the greatest economist, the policy mix of abolishing the consumption tax that started about 30 years ago and escaping as quickly as possible the abnormal monetary easing of negative policy interest rates is the key. I see this as the key. What do you think about Bard?

 

(Bard) As you point out, long-term "structural reforms" such as digitalization, regulatory reform, and labor market flexibility have been proposed in much the same way for the past 30 years. However, all structural reforms to date have failed to produce sufficient results. Reasons for this include:

• There was insufficient public understanding of the necessity and importance of reform.

• There was a lack of political leadership to promote reform.

• Implementing reforms requires significant costs and time, and may conflict with short-term political interests.

 

This year's Economist magazine special feature on Japan points out that the following points are important to overcome these challenges.

• Strengthen educational activities to make the public widely understand the necessity and importance of reform.

• Establish political leadership to drive reform.

• Develop a concrete roadmap for the realization of reform and steadily promote it while gaining the understanding and cooperation of the public.

 

If these challenges can be overcome, long-term "structural reforms" such as digitalization, regulatory reform, and labor market flexibility could have a significant effect on reviving the Japanese economy. .

 

On the other hand, if we follow Keynesian economic policy, the policy mix is to get away as quickly as possible from the abnormal monetary easing with the abolition of the consumption tax that started about 30 years ago and negative policy interest rates. It would be reasonable to say that this is the key.

 

The abolition of consumption tax is expected to have the effect of promoting economic growth by increasing people's disposable income and expanding domestic demand. In addition, moving away from negative policy interest rates is expected to improve the profitability of financial institutions and encourage companies to increase capital investment and productivity.

 

All of these policies will have a short-term economic stimulus effect and will be important tools for reviving Japan's economy.

 

However, implementing these policies involves risks such as expanding fiscal deficits and turmoil in the financial system. Therefore, it is important to consider these risks carefully and implement them in a timely manner.

 

In conclusion, I think it is important to take a dual-pronged approach of long-term structural reforms and short-term macroeconomic policies in order to re-emerge the Japanese economy.

 

(Nakamaru) I see, you have a point.

 

(Bard) Yes, I think so.

Long-term structural reforms are essential to solving the fundamental problems of Japan's economy. However, short-term macroeconomic policies will also play an important role in reviving Japan's economy.

 

In order to realize a two-pronged approach, political leadership and public understanding are essential. The government needs to strengthen its awareness-raising activities to make the public widely understand the necessity and importance of reform, and establish political leadership to promote reform. The people need to understand the need for reform and work together to realize it.

 

In order to re-emerge the Japanese economy, it will be important for the government and the people to work together to realize a dual-pronged approach that includes long-term structural reforms and short-term macroeconomic policies.

 

(Nakamaru) I see, that may be true. But will the current rise in inflation and amplification of asset bubbles give us such time?

 

Taro Yamamoto, representative of the Reiwa Shinsengumi, just “screamed'' at an extraordinary Diet session that “the ruling party is coming to kill the people,'' and appealed for the “crisis of rising living costs.''

 

In addition, due to the endless fiscal expansion and the continuation of a different level of monetary easing centered on maintaining negative policy interest rates, asset bubbles such as Japanese stocks, real estate, and exchange rates are expected to explode (big bang) within this year or by the end of FY2023 at the earliest.

 

There is no time for the people to come to an agreement on a difficult long-term strategy, and one could argue that Japan can only change through a financial crisis.

 

(Bard) As you pointed out, the current rise in inflation and the amplification of asset bubbles pose major risks to the Japanese economy.

 

Rising inflation can put pressure on people's lives and impede economic growth. Furthermore, the bursting of asset bubbles may cause financial system turmoil and economic stagnation.

 

Under these circumstances, it may become more difficult to gain the understanding and cooperation of the public in order to advance long-term structural reforms. In addition, the implementation of short-term macroeconomic policies increases risks such as widening fiscal deficits and financial system turmoil.

 

Therefore, it is possible that the financial crisis will lead the public to understand the necessity of structural reform and come to support it.

 

However, a financial crisis not only makes people's lives even more difficult, but also has the

potential to have serious effects, such as economic stagnation and rising unemployment rates.

 

In order to advance long-term structural reforms while avoiding a financial crisis, it is important for the government and the people to work closely together and implement appropriate policies at the right time.

 

Specifically, the following points will be important:

• Considering an appropriate combination of monetary and fiscal policies to control rising inflation.

• Strengthen financial regulations and improve financial education in order to suppress the expansion of asset bubbles.

• Strengthen educational activities to make the public widely understand the necessity and importance of long-term structural reforms.

Through these initiatives, it is important to steadily advance long-term structural reforms while gaining the understanding and cooperation of the public.

 

(Nakamaru)…. Thank you. That's all for this week.

 

 

Tomo Nakamaru

Former World Bank Economist