Japan Needs Neighbor’s Love, Not Cheap Money
Various attempts to establish an early – and negative – market verdict on Japan's efforts to eradicate deflation are unfair and plain wrong.
The proposed stimulus measures should be given a chance to show what they can do. Jumping to sweeping conclusions based on a few weeks of volatile trading is poor judgment. Especially since the recent behavior of Japan's key financial market variables (stock indices, the yield curve and the yen's exchange rate) could be seen as a sign of support for reflationary policies.
This paper, however, proposes a different approach: Before pressing the overdrive button on money printing presses, Tokyo might wish to take a careful look at why the last 15 years of ultra-loose credit policies failed to move the economy closer to its estimated potential growth rate of 1.5 percent.
Indeed, the evidence I reviewed does not support the view – expounded by the new Bank of Japan management – that by buying more longer-dated securities (i.e., running printing presses a bit faster) will boost upward pressures in labor and product markets to bring stronger economic growth and an inflation rate of 2 percent.
But that is what would have to happen, because the current consumer price deflation of -0.3 percent cannot be stopped, and reversed, without rising employment creation, accelerating wage claims and a sustained increase in the growth of domestic demand.
This needs to be emphasized because the reductionist refrain of 2 percent inflation sounds like a move of a magic wand. The reality is very different: ending Japan's deflation and pushing the economy onto a higher growth path is a serious structural problem.
Stagnant Economy Despite Loose Money
To see that, here is what happened in Japan over the last 15 years. Average short- and long-term interest rates over that period were 0.3 percent and 1.5 percent, respectively. Given the average inflation rate of -0.2 percent during that interval, real short- and long-term interest rates of 0.5 percent and 1.7 percent indicate an easy credit stance and a low cost of capital.
In spite of that, Japan's average annual growth rate since 1997 was only 0.7 percent, mainly because the interest-sensitive segments of the economy – household consumption and residential investment, 62 percent of the gross domestic product (GDP) – were not responding to very low credit costs. The result was that nearly two-thirds of Japan's GDP grew only at an average annual rate of 0.5 percent.
The low cost of capital, over the same period, did not help business investments either; they increased at an average annual rate of 0.8 percent because the poor sales outlook at home did not require large expansions of production capacities, and exports were increasingly sourced from overseas factory outlets.
The key message conveyed by these numbers is this: Japan's loose monetary policies of the last 15 years could not produce a growth rate strong enough to lift the economy out of deflation. Hence the question: Is it reasonable to expect that marginally looser policies would now lead to more than tripling of the growth rate (to 1.5-2 percent) over the next two years, while raising the inflation rate from -0.3 percent to 2 percent – as the Bank of Japan is promising?
In other words, would pushing the short-term interest rate down to 0 percent, from the current rate of 0.16 percent, propel the GDP growth and inflation to such permanently higher levels?
I don't think so. I believe that changes are needed – well beyond cheaper money – to achieve these policy objectives.
Boost Private Consumption and Housing
This should be the key nexus of Japan's policy concern. These two segments of aggregate demand reinforce each other because buying a house or an apartment triggers spending on consumer durable goods ("big ticket" items) such as furniture, appliances and even automobiles because relocations typically change commuting patterns and lifestyles.
But all this requires more than cheap credit. Housing has to be affordable, and the demand for housing crucially depends on net family formation and higher birth rates.
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None of this is seriously addressed in Japan's latest stimulus package. That is a pity – and a mistake. Japan's population has been declining since 2006. If the present birth rate of 1.37 births for women of childbearing age continues, Japan could lose one-third of its population by the middle of this century. A much higher birth rate of 2.1 births is needed just to keep the population from declining.
That now seems beyond reach because family support policies are woefully inadequate. Nearly three-quarters of Japanese women have to leave the workforce after their first child. Daycare centers are hugely expensive and have long waiting lists in most urban areas.
It is incredible that the Japanese public opinion, and the Japanese leaders, seem oblivious to these existential problems of an old and distinguished civilization. And that more proverbial "bridges and highways to nowhere" continue to take precedence over family support policies that could serve as a formidable engine of economic growth.
Exports and Cheap Public Financing
In view of all this, the announced further loosening of Japan's monetary policy might just do two things. One, it could stimulate exports by keeping the exchange rate low. Two, it will keep down interest charges on public debt – a whopping 237 percent of GDP. I see little else. And, apparently, I am not alone. Failing to see any other benefits of this extra push for monetary creation, some analysts believe that the monetization of the growing mountain of government liabilities is the main objective of Japan's new money managers.
Whether that is true or not will be seen soon enough. But it is clear that cheap money will remain the centerpiece of Tokyo's quest for faster growth and rising inflation. Widely advertised "radical structural changes of the economy" – presumably as a result of Japan's negotiations to join the Trans-Pacific Partnership (TPP) trading group – are no more than talking points. Washington seems to have made these reforms unlikely by offering plenty of exemptions and opt-outs to get Japan on board.
I, therefore, doubt the effectiveness of Tokyo's latest effort to revive its stagnant economy by throwing at it a new wall of money. But let's see; maybe they will improve things as they go along.
In that vein, Japan needs no reminding that there is a much simpler and faster way of stimulating economic growth and getting out of deflation. To do that, Japan would have to restore and maintain peaceful and cooperative relationships with China, Russia and South Korea. Despite sharply declining sales to China and South Korea, these three countries still accounted last year for 32 percent of Japan's total exports. There is a huge potential for Japanese products and services in these steadily growing markets.
Here is hoping that Japan will find a way of establishing better ties with its closest neighbors.
Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.