Those pushing for monetary stimulus are misled by low price inflation in Japan – Analysis – Eurasia Review


By Mihai Macovei *

Until recently, the heavy monetary and fiscal easing triggered by governments to stimulate economic recovery at the onset of the global financial crisis did not have major inflationary repercussions, especially since the main benchmark has been the benign consumer price inflation, rather than the rapid growth in house prices and stock markets. At the same time, so-called modern monetary theory has become very popular with academics and market analysts. The theory incorrectly claims that governments using fiat currency can afford to monetize large budget deficits without fear of negative economic consequences. Inflation problems were dismissed as highly improbable and easy to resolve with subsequent policy measures. Japan has been the preferred example of proponents of modern monetary theory because of its low inflation despite massive growth stimuli. Yet given its specific conditions, Japan is a misleading case and the economies that have emulated its policies are now facing rapidly rising consumer prices.

Japan’s senseless fight against deflation

Shortly after the collapse of its asset price bubble in the early 1990s, Japan entered a prolonged period of anemic growth and low inflation with short periods of deflation (Figure 1). Instead of allowing prices to readjust and a healing recession to purge the boom’s bad investments – as Austrian business cycle theory advocates – the government has engaged in massive fiscal and monetary stimuli for three decades. Japan tried to stimulate sluggish demand with a Keynesian public works program and large budget deficits peaking at more than 10% of gross domestic product in 1998 and 2009. At the same time, public debt increased nearly four times. , rising from 63% of GDP in 1990 to 235% of GDP in 2019, largely monetized by the central bank. Needless to say, economic growth has been disappointing.

Graph 1: Evolution of real GDP, the consumer price index and the M2 money supply of Japan

Source: FRED.

The Bank of Japan (BoJ) launched a series of unconventional policy measures very early on (IMF 2020). In 1999-2001, it became the first of the major economies to experiment with a zero interest rate policy and introduced quantitative easing at around the same time (graph 2). In 2013/2014, the BoJ sharply increased its purchases of Japanese government bonds and risky assets via quantitative and qualitative easing, and surprised market participants in early 2016 with negative interest rates for a part bank reserves. In September 2016, the BoJ launched a new program, the control of the yield curve, in order to raise inflation expectations. He started buying government bonds across the yield curve with a 0% target for the ten-year yield and pledged to allow inflation to “exceed” the 2% target. As a result of this experience of monetary expansion, the BoJ’s balance sheet grew from around 30% of GDP in 2013 to over 120% of GDP in 2019, and its holdings of Japanese government bonds reached 90% of GDP. GDP in March 2020 (Chart 3).

Figure 2: The story of monetary easing in Japan

Source: IMF.

Figure 3: Balance sheet size: Bank of Japan versus other central banks

Japan’s conditions were very specific

The reasons why Japan’s decades-long monetary easing did not translate into a rise in the consumer price index are different from what mainstream economists thought. First, as Rothbard explains, the crisis following a credit boom is accompanied by a contraction in the money supply which, together with an increase in the demand for money, leads to a downward adjustment in prices. Far from being detrimental to the recovery, it leads to a greater price differential, that is to say a higher “natural” interest rate between the stages of production, which accelerates the remediation of problems. investments and replenishment of savings. Although the Japanese authorities did their best to avoid deflation and a healing recession, their actions only succeeded in keeping zombie companies and banks alive, which prolonged the recession and the misallocation of factors. of production. Yet they were unable to restructure another boom or meet the 2% inflation target because the credit multiplication mechanism and money transmission channel were clearly compromised. Figure 4 shows the huge growth differential between the monetary base under central bank control and the broad money supply determined primarily by lending activity.

Chart 4: Japanese monetary base (M0) and broad money (M3)

Source: FRED and Bank of Japan. Note that January 1980 = 100.

Second, the impact of the BoJ’s aggressive monetary easing was mitigated by large capital outflows triggered by the low yield environment and deteriorating domestic economic conditions. Although leading experts claim unfavorable demographics and deflation are the root of Japan’s lost decades, in reality pernicious government policies are to be blamed (Macovei 2020). As unprofitable businesses were kept afloat, wasting scarce resources and labor, and raising production costs for all businesses, viable businesses moved capital and investment overseas. In less than four decades, Japan has accumulated the largest net international investment position in the world, with around $ 3 trillion, or 60% of GDP (graph 5). In the past two decades alone, Japan’s net international investment position has grown by the equivalent of 225 trillion yen. If this amount had been invested in Japan, the broad money supply would have increased by 75 percent instead of about 50 percent during this period, with a corresponding effect on domestic prices.

Chart 5: Japan’s net international investment position as a percentage of GDP

Third, inflation expectations, particularly in the short term, have remained moderate and very much in line with real inflation despite very expansionary fiscal and monetary policies (Chart 6). The woes caused by the slow economic recovery, the bankruptcies of financial institutions and concerns about the fragility of the national financial system in general have caused inflation expectations to fall, except for a short-lived spike. at the start of Abenomics.

Chart 6: Short-term inflation expectations

In addition, Japan’s inflation expectations have been largely influenced by past inflation, leaving inflation targets a lesser role to play. This sets Japan apart from other advanced economies, including the United States, and reflects specific wage behavior (Borrallo Egea and Río López 2021). Despite labor shortages and a low unemployment rate, wage growth has been weak for many years, influenced by labor market distortions in Japan (Figure 7).

Figure 7: Wage growth in Japan

Historically, lifetime employment and seniority pay have become common practice in large Japanese companies, under pressure from unions and facilitated by the period of strong growth in Japan (Moriguchi and Ono 2004). No law guarantees lifelong employment, yet several court rulings in favor of them, including for non-union employers and small businesses, as well as government interventions to subsidize employment, especially for older workers , have transformed job security expectations into standards. Today, Japan has a dual labor market, with most workers on regular full-time contracts and prioritizing long-term job stability over demands for wage increases. As a result, in annual wage negotiations, unions focus more on realized inflation than expected inflation.

The seniority-based salary makes it difficult to transfer mid-career workers to another company, which would likely lead to lost wages. As employees age, their wages tend to exceed their productivity, forcing companies (over 80% currently) to set mandatory retirement at sixty (Economic Development Cooperation Organization 2019). Subsequently, most senior employees are rehired on non-regular contracts at significantly lower wages, which also dampens the remuneration of young people in non-regular employment. Japan’s rigid employment and compensation system not only reduces labor mobility and productivity, but also inflationary pressures from wage demands.

According to the Bank of Japan’s Tankan survey (or short-term economic survey of companies in Japan), companies’ short-term and long-term inflation expectations have also fallen sharply, from 1.5% to 1 % in recent years (Borrallo Egea and Río López 2021). This is mainly due to weak consumer demand, which has prompted companies to try to cut costs and limit price increases. Finally, another factor reducing inflationary pressures is Japan’s leaner social protection system, which reduces the possibilities of monetizing large social spending. Despite its aging problem, public social spending, at around 22% of GDP, is much lower than that of major European spenders like France, Finland, Denmark and Belgium, at around 30% of GDP (Figure 8) . This reflects both the decline in social benefits and pensions, where the replacement rate for compulsory schemes is only around 37% for an average-wage earner in a career, compared to the OECD average of 59% (OECD 2019).

Figure 8: Public social expenditure

Source: OECD.


Japan has been seen as a leading example by modern monetary cranks of how managing the printing press to monetize large-scale budget deficits is unlikely to end in high inflation. Yet they failed to understand the fundamental and specific reasons why inflation in Japan has remained low during three decades of dismal economic performance. The recent surge in consumer price index inflation in the United States and many other countries is clear proof that Japan has always been a bad example.

* About the author: Dr Mihai Macovei ([email protected]) is an associate researcher at the Ludwig von Mises Institute Romania and works for an international organization in Brussels, Belgium.

Source: This article was published by the MISES Institute


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