Scott Sumner  

Japan and market monetarism

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The government of Prime Minister Abe is currently facing a major scandal, raising questions as to whether or not Abe can survive. This government has presided over a surge in NGDP growth, and a deep plunge in the unemployment rate, from over 4% to 2.4%. The nearly 2-decade period of deflation seems to have ended, at least for the moment.

So how would you expect investors to react to this news? Here's Bloomberg:

"Japanese politics had been very stable and this was one of the biggest things that attracted international investors," said Masaaki Kanno, chief economist at Sony Financial Holdings and a former official at the central bank. . . .

The controversy is likely to slow progress on labor market reforms and derail Abe's ambition of revising the constitution to clarify the legal status of the nation's military.

So this is clearly bad news for Japan. Given the almost universal view that the Abe administration has helped the Japanese economy, I'd guess that 99% of economists would expect this sort of bad news to weaken the yen. Isn't that what usually happens when a government viewed as "good for the economy" is hit by scandal?

But market monetarists are not like most other economists. We believe that Abe has helped Japan's economy by promoting a more expansionary monetary policy (not so much in absolute terms, but relative to what came before). It's important to emphasize that this monetary stimulus is an Abe project, and is not supported by the Japanese establishment. It is quite likely that Japan would go back to its deflationary policies of the 1990s and 2000s if Abe were to lose power. Thus market monetarists would actually expect the yen to strengthen on this "bad news".

And here's what actually happened:

The yen strengthened sharply earlier in the day amid concerns Aso would quit, casting a shadow over the fiscal and monetary stimulus programs that have weakened the currency. The yen retraced some of its moves when he stood firm.
PS. Notice the odd reference to fiscal stimulus. Some Keynesians try to make it seem like Abe's success reflects well on Keynesian economics. In fact, fiscal stimulus tends to appreciate a currency; it's monetary stimulus that depreciates a currency. In addition, Abe's government has not adopted a policy of fiscal stimulus, just the opposite. Abe has been raising taxes to reduce the Japanese budget deficit.

To his credit, Paul Krugman does not try to suggest that fiscal stimulus explains Japan's success:

When he became Prime Minister in 2012, Shinzo Abe - heretofore known as a conservative on any issues - surprised the world by endorsing a fairly radical monetary experiment. "Abenomics" was supposed to contain three "arrows" - fiscal stimulus and structural reform as well as monetary expansion. In practice, however, fiscal policy has if anything tightened slightly, while structural reform, as often happens, is in the eye of the beholder. There has, however, been a very visible shift not just in the Bank of Japan's actions but in its underlying attitude: while it still professes the conventional 2 percent target, it gives every indication of being willing to be far more adventurous than in the past in its efforts to achieve that target.

[Note "still professes" is a bit misleading, as Abe's government raised the inflation target.]

So how is Kurodanomics - a much better description in practice than Abenomics - working? Figure 6 shows two indicators, nominal GDP and the real effective exchange rate. Despite being at (or slightly below) the zero lower bound, the Bank of Japan evidently managed to achieve considerable traction. It has not so far managed to achieve the inflation target, but at least the Japanese experiment suggests some support for the view that monetary regime change can be effective even at the zero lower bound.
Kurgman's exactly right. The only thing I'd add is that Japan provides support for the policy mix of fiscal austerity and monetary stimulus.

PS. Krugman provides this graph, to support his argument:

Screen Shot 2018-03-12 at 12.10.47 PM.png

Comments and Sharing

COMMENTS (5 to date)
David R Henderson writes:

Nice post, Scott.

Iskander writes:

Shouldn't that graph compare NGDP to the nominal exchange rate?

Scott Sumner writes:

Thanks David,

Iskander, Yes, I'd prefer the nominal rate. I suppose he'd argue the two are highly correlated in the short run, so the graph would look similar either way.

Iskander writes:

That I was complaining about Paul Krugman's choice unnerved me for an instant.

If nominal shocks have real effects that last over 4 years (even more in the case of the UK in the 1920's), central banks really shouldn't allow NGDP growth to go off target.

So many unfortunate parts of history could have been avoided had monetary policy been better.

Scott Sumner writes:

Iskandar, That's right.


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