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Thursday, November 20, 2014

Abenomics - Mission Accomplished?

The news that Japan has entered technical recession was viewed as a "surprise" in the financial press, when it really should not have been. (Although to be fair to those who produce quarterly GDP forecasts, the timing of a recession would not be obvious.) This has prompted a few articles discussing the failures of Japanese policy. My feeling is that the Japanese may have accomplished their true objectives (which were not the ones publicly announced).

I liked the following recent articles on Japan.
The Bill Mitchell article provides a useful history of how the previous consumption tax hike in 1997 provoked a recession.

I wrote about Abenomics almost exactly a year ago in "Abenomics: Lift-off or Faceplant?". I had not completely ruled out the possibility of Abenomics working, as it was unclear whether the government would have the ability to get companies to raise wages. It is clear that they did not. Additionally, the possibility of Japan riding behind global growth momentum was always possible; absent a crisis, the tendency for capitalist economies is to grow. That hope was dashed by too-tight passive fiscal policy settings elsewhere. But the "New Keynesian" belief that monetary policies (that is, Quantitative Easing) would be dominant was always a pipe dream.

But it would not be fair to say that Abenomics was a failure; it seems to me that it accomplished non-disclosed objectives.

  • By stampeding domestic investors into foreign currency assets, the yen was weakened, increasing the competitiveness of Japanese businesses, and pushing consumers towards substituting domestic goods and services for more-expensive foreign ones.
  • Increasing foreign currency asset holdings creates a backstop against future currency crises. 
  • Putting the economy into recession by taxing consumption is one of the most effective ways to push a trade balance towards surplus.
  • A higher rate on the consumption tax means that fiscal policy will tighten faster if domestic inflation actually appeared. This should reduce worries about the inflationary risk posed by a large overhang of financial assets in an economy where the work force is shrinking.

Of course, these policy objectives are mercantilist and do not help improve the standard of living of Japanese citizens. But given the history of Japanese policymaking, it is unclear that raising the standard of living is their highest priority.

(c) Brian Romanchuk 2014


  1. you provide good analysis on why abenomics didn't work but you neither: a) provide reasoning of what you would have done differently; b) the counterfactual of what you would have done in the stead of abenomics.

    1. That's a great question. I am used to writing as a fixed income analyst, where I write what I think will happen based on given policies, and not what I think ought to happen. Since I have not thought about this very hard, I am going to have to give a rough answer.

      If my objective is to maximise the standard of living of Japanese citizens in a conventional fashion, it seems to me that the pre-Abenomics policy mix was working. Once we accept that Japanese government debt levels will be high because there is a high demand for domestic financial assets, it is unclear that anything needed to be done.

      If we wanted to follow my personal policy preferences, I would launch a fairly intensive push towards transitioning away from a dependence upon oil. Although the private sector would eventually get involved, this would have to be government-led as fossil fuels are still cheap, and there is no economic incentive for private actors to make a transition. The consumption tax could have been raised as an inflation brake if the required spending was large.

      If we granted the "New Keynesian" position that deflation was a problem, the correct response would be to mildly raise short-term interest rates (to 1%). This would create the interest income to fuel inflation, and reduce the need for precautionary savings. Note that Japan had price level stability and not deflation, so I think any such policies are wrong-headed. Additionally, the implication is that the Bank of Japan understands interest rate policy backwards - hiking interest rates will raise the inflation rate. This could spiral out of control if they try to contain the inflation caused by higher interest rates by raising them, further. (This last point follows what is called the "Neo-Fisherite" view. I am unconvinced that "Neo-Fisherism" always works, but I believe that it is applicable in the current situation of Japan. It is no accident that locking the short rate at 0% did not raise inflation.)



    The impact of monetary policy must be dependent on the number and term structure of outstanding interest bearing Govt liabilities. Which is why both neo-fisherites and new-keynesians must be wrong. It cant be the case that:

    CB;s raising rates always lowers inflation
    CB's lowering rates always raises inflation

    Or the neo-fisherite opposite, its just not technically possible to make a blanket statement about monetary policy in this way.




