Posts tagged inflation

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.

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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.

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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.

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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.

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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.

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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

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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.

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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#

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Is Abenomics Coming to a Halt?

Abenomics

Abe Shinzo, the Japanese Prime Minister, advocates yen devaluation

Wall Street Journal: Abenomics Will Be Felt Beyond Yen

Hankook Ilbo(Korean): 아베노믹스 ‘거꾸로 효과'(Abenomics ‘Reverse Effect’)

Abe Shinzo had explicitly announced that he would artificially devalue yen in the hope that this will help its export-dependent economy. His idea was that devaluation of yen against other currencies, especially USD, would improve price competitiveness of Japanese products overseas. This announcement was quickly criticized by many nations dependent on export such as Korea and Germany.

The Japanese government said that it would pump ‘infinite’ amount of money supply in the economy until it reaches its target inflation rate of 2%, thus achieving the devaluation of yen. Wall Street Journal expected that the inflation rate would make it less attractive for Japanese households to save and invest their money else where or simply use them to go on shopping. “Deutsche Bank said in a note Wednesday, spurring a “meaningful reallocation” of these deposits into offshore assets.” Therefore, Abe’s policy should have helped to vitalize the consumer sector of Japanese economy and at the same time increase its export to foreign countries.

However, Hankook Ilbo, a Korean newspaper, has published an article that Abe’s devaluation of yen is actually having a reverse effect on Japanese economy. According to the report published by Japanese Ministry of Finance in February 20th, 2013, exports decreased 9.4% compared to the previous month, while imports increased 8.2%. This resulted in 1.63 trillion yen deficit.

The newspaper analyzed that the main reason for this deficit is the rising prices for the energy imports due to the yen devaluation. The nation has been importing more of energy supplies such as LNG, oil, and naphtha, as it tried to diversify energy usage and reduce nuclear power following the Fukushima Nuclear Accident. According to Hankook Ilbo, “If Japanese firms fail to significantly recover from this deficit, Abenomics will be hit hard.”

In addition, many Japanese firms are showing their reluctance in raising wages for workers, which is very important for Abenomics to work in order to revive the real economy. They believe that devaluation alone will not simply rejuvenate the economy. Many Japanese companies have been outsourcing their factories overseas and it would be very hard to retrieve all those back to Japan in very short period.

Of course, it has only been several months, so it will be hard to tell whether Abe’s yen devaluation is doing well for the Japanese economy. But, I think that, from reading these articles, it would be better off for a Japanese economy to appreciate yen due to significant the increase in the energy import. The devaluation certainly is doing no good for Japanese economy and disturbing other export-driven economies such as Korea, Germany and etc.

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China on Equity vs. Efficiency

Should China slow down and focus more on Equality rather than Efficiency?

The Economist: News Article

As the gap between the rich and the poor increases substantially, China’s prime minister, Wen Jiabao, has ordered the new upcoming president, Xi Jinping, to “satisfy the people” by focusing more on the equality. Wen Jiabao has set a low target of 7.5% growth rate for Xi Jinping in order to slow down the overheated economy, lower the inflation rate, and focus more on dividing the economic pie equally for the people.

This old debate about whether an economy should focus on equality or efficiency is a ever-real problem for China as its economy is growing at double-digit growth rate, however, the gap between the rich and the poor has widen. This gap stirs the conflict between the people and the government as they get upset about the problem. There has been outburst of unrest in many parts of China in relation to the low income and the ever-increasing inflation rate.

Therefore, this political situation has forced the Chinese government to focus more on the equality. Otherwise, the government will soon lose the support from people and authority, which will result in the demise of the communist China.

I think that the Chinese officials are well aware of the trade-off of focusing more on equality. The economy will soon lose the efficiency once it had and the economic pie will shrink, instead of increasing. Surely the officials will be able to slice the pie more equally for the poor, however, this will act as a disincentive for the rich to work hard, which lead to the shrinkage of the economic size. In short term, the poor experience the prosperity from equality. However, in the long run, “The poor will get poorer and the rich will get less rich,” which is a quote by Margaret Thatcher.

This is a video of Magaret Thatcher commenting on socialist policies and how everyone will be hurt by focusing on equality.

China’s GDP per capita is only $8,394 according to the recent data from IMF (2011). Its GDP might be the second biggest in the world, however, there are too many people, which decreases the GDP per capita. UK’s GDP per capita was absolutely higher than China’s around 1990, and they were still arguing about equality verses efficiency. UK led by Margaret Thatcher focused more on efficiency. China will almost certainly decrease its economic pie if Xi Jinping focuses on equality. If I were at the decision-making position, I would certainly have focused more on efficiency. I would focus on equality later when the GDP per capita is high enough.

I understand that China has to satisfy and relieve complaints from their people to sustain political power. I am also aware that the government is focusing on slowing down the economy at an appropriate level. However, if the economy loses its economic momentum from socialist policies, the chance that China will become a developed country will decrease substantially.

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How can Monetary Policy help people represented by Silver Cougars?

Angela Soracco of Silver Cougars of America has sent a letter quite concerned about the current inflation of 9%. Silver Cougars of America is an organization of senior citizens and they are being heavily relaint on Social Security day by day. How can the government implement monetary policies to help old seniors to lay off the inflation burden?

There are two ways to control the inflation. First is to increase the interest rate and second is to cut down the money supply on the market. First of all, by increasing the interest rate, many people will tend to save their money and not spend. This will lower the demand-pulled inflation to some degree. Also, by cutting down the money supply flowing through the market, the value of the currency will go up and therefore it will lower the inflation rate.

Nonetheless, there is one serious drawback to this policy. It will aggravate the negative economic growth and skyrocket unemployment rate in return. So, there is a trade off. Governments would look at the opportunity costs of implementing this policy and consider whether it will be worth of a try or a bad choice.

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Greek Bonds are Useless Junks says Standard & Poor’s

BBC News: Click Here

According to BBC News, global stock markets tumbled after Greece’s debt was downgraded to “junk” by rating agency Standard & Poor’s over concerns that the country may default.

As uncertainty of whether Greece will get financial support from EU and IMF to clear up its looming debt increases, many rating agency such as Standard & Poor’s has rated Greek bonds as junks, rubbish.

What does it mean when a rating agency says that now Greek bonds are ‘junk’? It means that it is now very risky to invest on. It is mainly because of Greek’s apparent lack of ability to pay its bills. So there is a higher chance that an investor will lose money for investing in a country falling into the abyss of ever increasing debt.

Greece’s finance ministry said in a statement that the downgrade “does not correspond with the real data of the Greek economy.” Greek finance ministry denies that the down-rating doesn’t reflect the real Greek economy, however, this incident showed investor’s distrust toward the Greek economy.

If Greece does not take action to reduce debt and get help from the EU and IMF, it may default.

What’s default and what happens if a country defaults?

Lets look into what the definition of default is. Default is simply announcing that you cannot pay the debt in the due date. It doesn’t mean that the government will go bankrupt and the debt wouldn’t go away. The debt will always be there and the investors/lenders will demand you to repay the debt whenever possible.

What are the consequences of a country defaulting? There are several effects to this. First of all, the currency of the country becomes a rubbish or a paper tower (or no better than a paper tower). Foreign investors will have distrust against the currency of the defaulted country and the value of the currency will drop significantly. As the value of the currency goes down, it makes the imported goods insanely expensive, which will lead to inflation and shortage of necessary goods. If a country has high food dependency on importing, many people will starve to death as there are simply shortage of food due to expensive importing.

People will loose confidence and the recession or more like disintegration of economy will be in a vicious circle. So by this stage, there is ultimately nothing a country can do to recover. So Greece should get help from EU and IMF quickly by giving them confidence that they can pay back the borrowed money.

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China bank lending falls sharply

BBC News: Click Here

According to BBC News, Lending by Chinese banks fell sharply in the first three months of the year after the government’s efforts to clamp down on new loans proved successful.

China has been suffering from unstable price control, and recently its inflation went up to about 3%. Controlling inflation is one of the key roles of Chinese government in order to maintain stable economy and acquiesce people’s complaints.

As you see, China’s inflation is pretty high right now. Chinese bankers knew that it was from excessive flow of yuan in their economy. So they simply reduced lending, and it effectively controlled the inflation getting out of control.

The article further on discussed about China’s recent trade deficit. The article analyzed that this deficit resulted from rise in volumes and prices of raw materials. However, ironically, China has hit $2.5 trillion of foreign exchange reserves. This is approximately 1/5 of  US GDP, which implies that Chinese economy is amusingly doing fine despite the recent trade deficit.

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