Posts tagged government

Will ‘Abenomics’ Save the Japanese Economy?

Abenomics

アベノミクス: Abenomics in Japanese

PDF File: “Will ‘Abenomics’ Save the Japanese Economy?” by Kim Sang Keun

I. Introduction

Ever since Shinzo Abe came to power, the Japanese government led by LDP has vowed to revive the stagnant economy by implementing bold economic policies. In effort to overcome so-called ‘Lost Decades,’ which has deteriorated the ego of many Japanese people, Abe has announced three simple economic policies that earned the name ‘Abenomics’ after its proposer. This includes indefinite quantitative easing, flexible public finance policy and economic growth strategy.[8] In this paper, we will look at the economic logic behind the Abenomics and problems and risks associated with it.

II. Economic Logic Behind Abenomics

Through Abenomics, the Japanese government hopes to revive its economy by implementing bold, powerful economic policies that will pull its economy out of deflation, depreciate Japanese yen, and induce CPI inflation rate of 2% per year. The Japanese government saw the constant decline of overall price level by lack of aggregate demand as the main culprit of the long-term recession that its country was going through.[3] In order to ‘reflate’ its economy, Abenomics tries to implement quantitative easing, fiscal policy through expanding government spending, and provide economic growth strategy. We will first look at the quantitative easing and its economic theory behind what the Abenomics is trying to achieve.

For analyzing the economic theory of Abenomics, the Mundell-Fleming Model for a large open economy was used in this paper as the main model. The following are the IS-LM equations for the model:

IS: Y = C(Y-T) + I(r) + G + NX(e)

LM: M/P = L(r,Y)

Notice that the assumption of r = r* was dropped, which is an equation for a small economy that cannot influence the world interest rate. As Japan is the third largest economy in the world, the assumption that it has little influence on the world financial market had to be dropped. Therefore, the interest rate was treated as an endogenous variable. As a result, LM curve got a positive slope, instead of being vertical.

2

3

First of all, the Bank of Japan is targeting a 2% CPI inflation rate and increasing the money supply circulating in the economy by buying various financial assets such as the government bond, which is essentially monetary expansion policy.[3] It could be said that this indefinite quantitative easing is the core of Abenomics. On the graph above, the increase in the money supply shifts the LM curve to the right, raising the income from Y1 to Y2, and lowering the real interest rate from r1 to r2. The decrease in the real interest rate then increases the net capital outflow as is illustrated on the second graph.

4

As the net capital outflow increases from CF1 to CF2, the supply of Japanese yen in the market for foreign exchange increases. The exchange rate falls from e1 to e2, depreciating the Japanese yen. This makes the Japanese goods relatively cheaper to foreign goods and the net export rises from NX1 to NX2. There are two channels for this mechanism. First, as the monetary expansion lowers the interest rate, this stimulates the investment. Second, as the monetary policy causes the currency to depreciate in the market for foreign exchange, this stimulates net exports.

5

All in all, the Abenomics tries to devaluate its allegedly over-appreciated yen and cause an inflation rate of 2% as the output increases. As a result, the Japanese yen has depreciated until the 103.42 (JPY/USD) recently on May 22nd. This is the lowest in almost 6 years, ever since the Global Financial Crisis that hit the economy around the world in 2007. This is shown in the exchange rate graph above.

6

7

Secondly, the Japanese government is trying to initiate fiscal policy by expanding government expenditures. As the government implements fiscal expansionary policies the IS curve shifts to the right. As the graph above illustrates, this shift in the IS curve leads to an increase in the level of income from Y1 to Y2 and an increase in the interest rate from r1 to r2. The increase in the real interest rate reduces the net capital outflow from CF1 to CF2.

8

As the net capital flow falls, the supply of Japanese yen in the market for foreign exchange falls. This induces the exchange rate to appreciate from e1 to e2, which decreases the net export from NX1 to NX2 as the Japanese goods become more expensive relative to foreign goods.

As the graph illustrates, the fiscal expansion by Abenomics will raise the income and output for the Japanese economy. However, it is to be pointed out that although implementing both the fiscal and monetary expansionary policies will increase the output of the Japanese economy, the effect on the exchange rate is conflicting. Yet, this problem is accounted for as the Japanese government will set its ‘desirable’ exchange rate, possibly above 100 JPY/USD, and fix it so that other variables can freely adjust, although it might compromise some of the output to some degree. Or if the Japanese government considers the increase in the economic output, and therefore the inflation rate, more important over the exchange rate, it might decide to compromise fixating the exchange rate to their ‘desired’ level for the economic growth.

Thirdly, on June 5th, the Japanese government announced the third policy for Abenomics, which includes economic growth strategy. The government announced plans for bringing up the financial integrity of Japan, however, there were no significant policies that were announced.

III. Problems and Risks Associated with Abenomics

9

10

There is a rising skepticism towards whether Abenomics would really revitalize the Japanese economy as the exchange rate appreciated breaking the 100 JPY/USD boundary and as Nikkei Index crashed. Although, theoretically, Abenomics has a sound Keynesian background, many are pointing out the fact that it is too focused on the demand side of its economy, not on the supply side.

13

Japanese Demography Data[11]

One of the fundamental problems that Japan is facing is its ageing population. As the population pyramid gets inverted, the labor population is shrinking every year. This brings about number of problems for the Japanese economy. First, the government commitment in spending on pensions, medical expenses and social security will continually act as a substantial burden to the already indebted country with a public debt of 240% its GDP.[11] This will further worsen the financial integrity of the Japanese government leading to an erosion of international confidence in Japanese economy. The lack of confidence can raise the risk premium (CDS) shifting the IS* curve to the left and LM* curve to the right, as θ increases for r = r* + θ. But, the exchange rate would depreciate more than what is desired by the Japanese economy, and it would force the Bank of Japan to decrease the money supply in order to bring up the yen value, shifting the LM* curve back to the left. This would aggravate the situation and lower the total income in the Japanese economy. This then would induce the interest rates to depress the prices of financial assets, which will then reduce the collateral being used as bank loans. As a result, this will lead to financial problems for Japan, further exacerbating the problems. Secondly, its dwindling workforce cannot sustain the economic output level that is maintained in the future.[11] As it is shown on the data, the demography will drastically change so that more young people will have to support for the older population, which implies that this change in demography is the main culprit for the last two decades of deflation and stagnant economic growth.[11] This has another implication to why the consumer demand might be falling behind.

In this sense, it could be said that Abenomics is failing to address the core problem of its economy. It must ask why consumer demand is inherently weak. Another major reason why the Japanese economy is stagnating is the poor productivity. This may sound strange to many people as Japan was once praised as technologically advanced country. However, according to the statistic, Japanese productivity lags badly behind world’s leading countries in many areas. For example, it lags 30% behind the U.S. in manufacturing with automobiles industry in exception.[9] Therefore, corporate reforms are needed in order to let inefficient firms downsize or die and be replaced to better ones.[9] In the case of Korea, as it suffered trough the so-called IMF Crisis in 1997, it underwent painstaking corporate reforms to let the inefficient firms die and raise the overall competitiveness of its economy. So it is doing relatively fine in terms of corporate competitiveness and financial integrity compared to Japan, although this is shaking a little due to Abenomics.

What is problematic right now is that the third policy for Abenomics lacks fundamental and specific content, which started to give erode out public confidence in Abenomics. As it was mentioned, this resulted in the crash of Nikkei Index and the re-appreciation of Japanese yen, breaking the 100 JPY/USD boundary. Shinzo Abe, afraid of losing the votes, has put aside the painstaking reforms to later, such as corporate tax cuts that will improve the productivity of Japanese firms. There was a discussion within the Japanese government in cutting the corporate taxes from 30% to 20% and to implement new policies that will make the labor market flexible.[5] However, flexible labor policy means temporary job losses[11], and it seems that Shinzo Abe is putting these essential reforms after the Japanese upper house elections. This could erode out confidence in Abenomics losing its force towards reviving the economy.

There is another risk associated with Abenomics. As the yen depreciates, net export increases as domestic products gets cheaper abroad, however, imports get more expensive. This is a big problem for Japan as ever since the Fukushima nuclear disaster, the word ‘energy crisis’ was lingering around the Japanese newspapers for two years. As Japanese public refused to use nuclear power, the Japanese government had to turn to more expensive imported energy, such as LPG, oil and naphtha, increasing the monthly value of Japanese energy imports from 1.4 trillion yen to 2.2 trillion yen.[12] This could deteriorate the competitiveness of Japanese companies, as energy prices go up. In addition, export accounts for only about 14% of its economy.[1] So the core of Abenomics should be in order to revive the domestic economy, not through export. The increase in energy prices could raise the domestic consumer prices without actually improving the income of the Japanese firms and consumers. Therefore, there is a risk towards Abenomics in that expensive energy imports will drag the Japanese economy into another lost decade.

IV. Conclusion

In conclusion, Abenomics is a sound Keynesian policy that could save the Japanese economy from deflation. The Mundell-Fleming Model was used to illustrate the economic theory behind Abenomics. However, there were considerable risks associated with Abenomics, such as the ageing population, poor productivity and the energy crisis. The key to success for Abenomics would be dependent on whether the Japanese government effectively manages these risks and confronts the fundamental reforms that would improve the supply side of its economy.

Reference

1. 박영철, 아베노믹스 실패 가능성 높다, <주간조선>, 2013.03.18, http://weekly.chosun.com/client/news/viw.asp?nNewsNumb=002248100014&ctcd=C05

2. 박형준, 日 환율-주가-금리 3각 부메랑… 아베노믹스 두달만에 휘청, <동아일보>, 2013.06.05, http://news.donga.com/3/all/20130605/55643597/1

3. 이형근, 아베노믹스, 디플레이션 탈출과 엔고 시정 추진, 2013년, 평화문제연구소, 통일한국 제352호, pg34-35, http://www.dbpia.co.kr/Article/3129836

4. 정성춘, 이형근, 서영경, 일본 아베노믹스의 추진 현황과 정책 시사점, 2013년, 대외경제정책연구원, 오늘의 세계경제, Vol. 13, No. 5

5. 차학봉, 아베노믹스 세 번째 화살 ‘不發’, <조선일보>, 2013.06.06, http://news.chosun.com/site/data/html_dir/2013/06/06/2013060600263.html

6. 한영기, 아베노믹스의 효과 및 과제, 2013년, 한국은행 동경사무소

7. 한창만, 아베노믹스 ‘거꾸로 효과’, <한국일보>, 2013.02.20, http://news.hankooki.com/ArticleView/ArticleView.php?url=world/201302/h2013022021083122510.htm&ver=v002

8. Adams, W. J. (2013). Japan: Assessing the Future of Abenomics, The Boston Company, http://www.thebostoncompany.com/assets/pdf/views-insights/April13_Views_Insights_Future_of_Abenomics.pdf

9. Katz, R. (2013). Abenomics Is Bad Medicine, The Wall Street Journal, http://online.wsj.com/article/SB10001424127887324590904578287472450294546.html

10. Mankiw, N. G. (2013). Macroeconomics Eighth Edition, Macmillian

11. McNerney, G. J. (2013). Will ‘Abenomics’ Ensure Japan’s Revival?, Thomas White International, http://www.thomaswhite.com/pdf/Will-Abenomics-Ensure-Japans-Revival.pdf

12. Schaede, U. (2013). Abenomics cannot succeed without cheap nuclear power, The Japan Times, http://www.japantimes.co.jp/opinion/2013/06/05/commentary/abenomics-cannot-succeed-without-cheap-nuclear-power/#.UbFlP-uPJBy

Data

13. St. Louis Economic Research: http://research.stlouisfed.org/fred2/graph/?id=DEXJPUS

14. Naver금융: http://info.finance.naver.com/marketindex/worldExchangeDetail.nhn?marketindexCd=FX_USDJPY

15. Naver금융: http://finance.naver.com/world/sise.nhn?symbol=NII@NI225#

Advertisements

Leave a comment »

California’s Tradable Permit on Oil Refineries

Californian Government Implements Tradable Permit on Oil Production

The Reporter: News Article

According to The Reporter, California decided to implement the tradable permit policy for the production of oil, which is responsible for the global warming. The government has budget deficit of “$9 billion” and it hopes to gain “$14 billion” by 2015, profiting from auctioning tradable permits to the oil companies.

The main reason for implementing tradable permit policy is that there is a negative externality associated with the production of oil. The social cost exceeds the private cost and this makes the society to take care of the environmental cost. In order to internalize the cost of pollution of the oil production and move the quantity supplied from Q market to Q optimum, the Californian government introduced tradable permit.

The government or EPA sets the amount of pollution allowed and auctions the pollution rights (tradable permits) to the oil companies. If the amount of tradable permit is appropriately chosen, it effectively moves the quantity supplied to Q optimum both eliminating the negative externality and increasing the government profit. The government would profit P times Q optimum amount of money.

However, some critics argue that the increase in the price of oil will increase the overall price of consumer goods. The cost of production will increase for virtually all the consumer goods that are produced from oil-running factories. Also, the means of transporting goods from city to city will be more expensive. All this will contribute in increasing the price of consumer goods. The economic size (or social welfare) would decrease also.

The overall increase in the price of oil and the price of consumer goods will lead to the decrease in the consumer spending overall. United States, especially California, is a place where the public transportation is not as advanced and popularly used as Korea. People usually drive their cars to go to work and go shopping. The increase in the price of oil will act as a disincentive for the people to go out on shopping. This will shift the demand curve from Demand 1 to Demand 2 decreasing the price of consumer goods from P2 to P1 and decreasing the quantity demanded from Q1 to Q2. Again, the economic size (or social welfare) will decrease. Some argue that the tax revenue form the taxes such as VAT will decrease countering the benefits by profits from implementing tradable permits.

In conclusion, the tradable permit will increase the profit of Californian government and at the same time cut down the level of pollution contributing to the global warming. However, the government should be fully aware of the complicated consequence or unintended effects of implementing any sort of policy distorting the market will have.

Leave a comment »

Plan to cut down US Public Debt failed

US Government’s Plan (1999) to Cut Down Public Debt

BBC News: Business: The Economy  US to buy back national debt

US Public Debt Data: Wikipedia file

I have found an interesting news article from 1999 about how US government was trying to cut down its public debts.

US government was planning to cut down public debts by paying the debts. The US government expected to decrease its debt of  $3,700 billion to $1,200 billion by 2009. However, as you can see from the actual data collected over 11 years, this plan wasn’t well executed.

The Actual Data of US Public Debt (1997-2008)

Instead of decreasing its debt to $1,200 billion, the debt increased to $10,000 billion. This suggests that the US government’s ‘plan’ to cut down its public debt was a poorly planned/executed policy.

According to U.S National Debt Clock, the US public debt is $13,621 billion or $13.6 trillion (Data Retrieved: 18 Oct 2010 at 12:38:23 PM GMT). I think that this increase in US public debt will someday have a detrimental effect not just on the US economy but on the economies around the world.

This blog post is an ‘add-on’ to the original blog post: Debt Time Bomb, Is It an Impending Death of Pax Americana?

Comments (2) »

How can demand/supply side policies help variety of people?

How should the government implement demand/supply side policy to help corporate leaders, unemployed workers and retired people? The government should utilize the policy that both stabilizes the inflation rate and lowers the unemployment rate to help all of these people. There aren’t any absolute solutions to these problems all simultaneously, yet there are always ‘best’ solutions.

The government could nullify the labor union’s power and make the wages flexible. By lowering to wages to an apt level, there will be surplus of money that can be used to employ a number of people. Also, the money that’s left could be used to increase the pension of the retired people. People who were employed will be angry, however, it’ll give them a strong sense of job security by looking at numbers of people coming in.

In order to protect the working population from the inflation, the government should implement the monetary policy in order to cut down money supply. By cutting down money supply, it’ll significantly decrease the inflation rate  to stable state. Also, the government could increase the interest rate in order to curb inflation.

Leave a comment »

What Greece must do to Survive the Debt Crisis

A frustrated Greek expressing his angry through violent protest

CNN News: Click Here

In action to fight off the increasingly unbearable debt crisis, Greece chose to get financial support from both EU (mainly Germany) and IMF. This might help Greece out of the problem in a short-run, yet they still have to pay back the money they have borrowed from EU and IMF. Now all Greeks must tighten their belt in order to fight off the crisis. There is a list of what Greece must to do recover their economy.

  1. Salary Cuts
  2. Retirement
  3. Increase in Taxation
  4. Reform in Pension System

First of all, all Greeks (at least public workers) will increase a cut in their salaries. Salaries are one of the big factors that take up large percentage of the cost in business and government spending. Though this will arouse some violent protests from the people, there is no other way to fight off the debt crisis without a cut in wages.

With some cuts in wages, many business and governments will want to minimize the number of employees as possible to decrease the money spent. This will result in early retirement of many workers with ages over 60. This will also contribute to the high unemployment rate, however, significantly cut the unnecessary budgets.

Interestingly, the Greek government decided not to have an early retirement for its workers but to increase the retirement. The retirement age was shifted from 61 to 65. It may be that Greece government didn’t want more unemployment and more protests regarding it. I think that the Greece government is tightening the payment of wages so much that they don’t need to cut down its workforce.

Greek people will most definetly exprience the rise in taxation. Greek government said that it was going to raise all VAT’s by 10%. Increasing taxation is one of the key ways that Greece can endure the crisis.

Greeks will also exprience a cut in pension. Unplanned pension system was the main culprits for the cause of Greece’s debt crisis. The government borrowed money, unplanned, in order to fulfil its populistic policy of pension system. The system supported too many people and gave out excess amount of money. So many aged Greeks will exprience this frustrating cut in their pension.

In sum, these were the actions that Greece must implement in order to survive the debt crisis. I think that the government’s determination to get out of the deb crisis is firm, but I think that this determination is not supported by lots of Greeks. Greek people must bear in mind that if they don’t start tighenting their belts, the government’s effort in order to get out of the crisis.

Leave a comment »

Saving is a Good Habit, but also a Bad Habit

Japan’s $15 Trillion Not Enough to Make It a Buy by William Pesek: Click Here

Is saving a good habit? If you look at Japanese people, they save a lot. As a result of assiduous saving, Japanese households have about $15 trillion according to the Bloomberg commentary by William Pesek. Wow, $15 trillion dollars! It’s higher than United State’s GDP of $14.2 Trillion (2008). However, the author acerbically criticized that Japanese people’s habit of saving is actually harming the Japanese economy for several reasons.

As you see, the saving is considered as a leakage along with importing and taxing. Why is saving considered a leakage? It is because the money saved is not used in the economy or market for long period of time. It is like blocking a current of river by building a dam. Saving is necessary, however, excessive saving can result in deflation, which Japan is severely suffering from.

Although the Japanese households have $15 trillion, they do not use it. This is one of the major roots of Japan’s lost decades and current economic crisis. The news columnist William Pesek claims that Japanese people’s saving of consuming is causing the deflation because the market has lack of currency flowing through it. If an economy is compared to a human body, people’s lack of consuming can be compared to low blood pressure. There just aren’t any money to get the economy going. Due to low demands for almost all the goods and services in Japan, the suppliers has to lower the price of their product. And this causes deflation, which William Pesek considers it to be a big problem for Japanese economy. The market is just hamstrung by Japanese’ excessive saving.

Japanese government’s public debt of 200% (to GDP) has resulted from this excessive saving too. Because there is a big leakage (saving) in the market, the Japanese government has to borrow from banks or households and pour it in the market to make it working. If the government do not support the market, the economic crisis would have been more devastating. As a result of trying to pour the money into the market, the Japanese government’s 45% of its spending is from Japanese’ households lending. This has further accumulated the public debt of 200% (to Japanese GDP).

Why are Japanese people reluctant in spending? It is from the lack of confidence about the future. The Japanese government is to be ascribed to the blame. The government did not take aggressive measures to tackle the problem. This has resulted in Japanese people’s distrust toward the government. The government now has to take aggressive measures to tackle the economic depression and encourage the people to spend more.

In sum, saving is a necessary habit, however, it could also hurt the economy if this is done excessively, when no one is willing to buy anything and just save money. I think that the best solution for Japanese economy to rise again to for the Japanese people to spend more again. Just think. If Japanese people spends all of $15 trillion, the GDP will surpass the US GDP. 🙂 yay and Japan will have the top GDP in the world. I personally do not think that that much of spending is worth it :(. Yet, this will be the best solution to the economic crisis in Japan.

Leave a comment »

Data Response: Clean Coal

(a) (i) Negative externality occurs when the production or the consumption of a product creates external cost to the society. For example, consumption of cigarettes can result in high possibility of cancer and air pollution.

(ii) Welfare loss occurs when there is a negative externality in the market. There is a loss of welfare when this negative externality is not reflected in the price mechanism.

(b) Graph 1:

Coal fired power stations produce negative externalities such as air pollution and acid rain. As you see in the graph, external costs of air pollution and acid rain are not reflected on the price. The production of electricity by usage of coal should be on the curve MSC, which rightfully reflects the negative externalities of the production. Instead, the curve is on MPC, which does not reflect the negative externaltities. Therefore, this engenders the welfare loss which is colored black in the middle of the graph.

(c) Graph 2:

In order to solve this problem, the government must intervene to overcome this market failure. The best solution to overcome this problem is for the demand for such polluting energy to go down. As you see in the graph 2, as demand goes down, the product becomes much cheaper and the consumption lowers down lessening the negative externalities of air pollution. The government could advertise not to excessively use the energy produced by the coal. However, this sometimes this method would not work. If this method does not work, government should use the last method of taxation on the production of the electricity by coal. This method is less-desirable than the first method. Although the consumption goes down, the price for the electricity goes up. So this would hurt the consumers.

(d) If the government taxes on the power stations producing electricity by coal, it will raise the price up from P1 to P* in the graph 1. This method will hurt the consumers. However, if the government tries to persuade the consumers to lower their consumption of electricity by advertisement, it will both lower the price of the electricity and the consumption. The best way for the government is to persuade the consumers not to consume electricity too much. The method of taxation should be considered as a last resort.

Comments (3) »