Some follow up to last week's piece on Japanese monetary policy:
First, I think there are some obvious implications for US policymakers: The Federal Reserve has all but given fiscal policymakers the green light to accelerate debt issuance to support stimulus efforts. Matthew O'Brien at the Atlantic points out that while the Fed is willing to tolerate inflation slightly as high as 2.5%, the Fed's forecast remains at 2.0% or below through 2015. So the Fed is willing to tolerate higher inflation, but not willing - or able - to generate higher inflation. The ball is thus passed to fiscal policymakers to do the job. Fiscal policymakers, however, have fumbled the ball. Badly. Even while the Treasury can borrow for 10 years at well below 2%, Washington is prepared to drop an austerity bomb on the economy. Austerity looks to be a done deal; it is only the level of austerity that is at issue.
Second, a thread is making the rounds claiming that Japanese Prime Minister Shinzo Abe is all bark, no bite. Joshua Wojnilower argues that Abe is a closet austerian, thus ultimately the actual stimulus enacted will be of the short-term, low-power variety. Noah Smith is less diplomatic, pointing out that Abe's first time at the helm was something of a disaster because Abe fundamentally has a narrow focus:
I of course don't mean to imply that Abe's cultural conservatism makes him unlikely to experiment with monetary policy (unlike in America, in Japan "hard money" is less of a conservative sacred cow). Instead, what I mean is that Abe really just does not care very much at all about the economy. I mean, of course he wants Japan to be strong, and of course he doesn't want his party kicked out of power. But his overwhelming priority is erasing the legacy of World War 2, with the economy a distant, distant second.
This is why Abe allows himself to be surrounded by corrupt and incompetent people. He is entirely focused on his cultural conservative quest. The other day Abe called Obama "Bush". He just deeply, truly, does not care about stuff that does not involve boosting Japanese nationalism.
Smith has a theory:
So why is Abe making all this noise about revoking central bank independence, setting hard inflation targets, etc.? I have a hypothesis: He is talking down the yen.
There is a long history of Japanese policymakers talking down the Yen; who could ever forget former Finance Minister Eisuke Sakakibara, AKA Mr. Yen? That said, if Abe wants a sustained depreciation, is is going to take something more than just talk. After all, look at what has been accomplished over the past ten years:
If the goal of all the talk was a weak Yen, policymakers have failed miserably. And If Abe can't follow through with a real policy change, talking alone will continue to fail, and the recent decline in the Yen will prove ephemeral.
This leads me to my third thought, that the level of intervention required to change the economic outcome is much, much higher than most anticipate. You can't just dabble in monetization; you need to commit to it. Case in point: Switzerland. Floyd Norris, the author of the original NYT piece that prompted my initial post, seems to argue that raising inflation is not all that hard:
“At this point, moving to a 2 percent target would not be such a giant step,” said Kenneth Rogoff, a Harvard economist who has suggested inflation targeting in the United States as well as in Japan. “They have to pursue it vigorously until we have inflation expectations firmly higher. No one knows how much they would have to do to accomplish that.”
The Bank of Japan has in the past been hesitant to really try to establish that credibility...
To establish the credibility, the central bank would have to show a readiness to create credit at a rapid rate. It would probably also need to take steps to hold down the value of the yen, a move that would no doubt cause concern in the United States.
It is, however, very doable, as Switzerland has shown. When the euro zone debt crisis was at its worst, Switzerland became a safe haven for European investors worried that the euro might blow up. That drove up the value of the Swiss franc versus the euro and damaged Switzerland’s ability to compete. The Swiss government responded by announcing that the euro would not be allowed to fall below 1.2 Swiss francs. If necessary, the government would simply sell francs to meet any demand.
That has been necessary, and the Swiss have accumulated a huge portfolio of foreign currency. So, too, could the Japanese if they chose to announce that the dollar would henceforth be worth at least 100 yen, a level not seen since 2009.
Rogoff is correct; no one really knows what is necessary. I don't think that 100 yen is a meaningful target; aside from a couple of energy-price induced spikes, Japan has not had meaningful inflation since the early 1990's. The Yen has fluctuated between 80 and 160 during that time. Shoot for 160 and it might be interesting. And how does this relate to Switzerland? Although Norris holds it out as an example, look at inflation in that economy:
The Swiss National Bank appears to be struggling to stave off deflation and stabilize the path of nominal GDP. So how exactly is this a lesson in establishing inflation target credibility? Despite all the efforts of the Swiss National Bank, their work still fall short.
Norris is certainly right on the political implications. I think the extent of direct currency depreciation necessary to by itself meet a 2% inflation target in Japan would be unacceptable to Japan's trade partners. Monetary policy to support domestic demand - monetization of deficit spending - would be much more tolerable, perhaps even welcome.
Bottom Line: Economic policy in Japan is never boring.