Monday, December 17, 2012

The Bank Of Japan Will Defeat The New Government

“Mr. Abe's economic platform consisted of more fiscal stimulus spending, to be financed by the Bank of Japan directly buying government bonds. In other words, printing money to bring inflation up to a new target of 2%-3%, compared to the BoJ's current target of 1%. But the central bank has expanded the money supply enormously, and demand for credit is so weak that it has been unable to stop deflation.”
---WSJ editorial, “Japan’s New Old Hawk”, Dec. 17th 2012

The Journal is giving the Bank of Japan credit for something it didn’t do. It is unclear where the Journal gets its monetary data for Japan. I get mine from the Fed, which show that money growth in Japan has been weak for twenty years, frequently going negative. M1, M2 and M3 growth rates have been bouncing around a very low mean of around 1% over those years. At present, under the BoJ’s supposedly reflationary policies, broad money (M3) is growing at 2.2%. Nominal GDP and industrial production have declined sharply since the crash.

The Journal is right that the BoJ has been unable to stop deflation, but that is due to its dogged pursuit of deflationary policies. It is now ten years since Ben Bernanke first explained to the Japanese the mechanics of NGDP targeting; only now is the government considering such a program. Twenty years of deflation and deficits have been wasted. Reflation is now the only way out for Japan, given its massive indebtedness.

The newly elected Japanese prime minister, Shinzo Abe, has embraced the advice that Bernanke gave Japan ten years ago: to target not interest rates, but either nominal growth or a target level of NGDP. Abe says that he will establish a monetary council, outside of the BoJ, that will set a 2% inflation target and a 3% NGDP growth target. If the BoJ ignores the council, he will take away the bank’s legal independence (long overdue).

I don’t know how to react to Mr. Abe. Most of what Japanese politicians say is meaningless. Japanese governments have been whining about the BoJ for fifteen years, so what’s new? My gut skepticism toward the Japanese political system suggests that one should not hold one’s breath waiting for a meaningful change in Japanese monetary policy. Furthermore, in typical Japanese fashion, the “radical” Mr. Abe has not called for a radical policy:  3% nominal growth will not change Japan’s debt dynamics when its fiscal deficits remain large (and will grow bigger under the new government).

Japan needs a radically reflationary policy now, not baby steps which are too little and too late. Bernanke advocated targeting the level of NGDP that would have occurred had the desired growth path not been interrupted. For Japan, that would be roughly 12% higher than today’s NGDP, not 3%. Mr. Abe is merely demanding that the BoJ do a tiny bit better than it has been.

Furthermore, students of Japanese politics will know that it will only take days for the Japanese media to proclaim Mr. Abe a failure and an embarrassment, no matter what he does or doesn’t do. In a year he will be gone, and the BoJ will still be there, “fighting” deflation.

This means that the Japanese economy will remain stuck in idle for another decade, the yen will remain strong, and the Nikkei (EWJ) will go nowhere.

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