Adam Posen on Japanese fiscal stimulus

The case for continued deficit spending in Japan ended by mid-2003.

…The additional stimulus in Japan is counterproductive because it adds to the long-term costs without addressing Japan’s real problem: a return to deflation and an overvalued exchange rate. The BoJ pursuing a higher inflation target through large-scale purchases of a wide range of assets, as Mr Abe and his economic adviser Koichi Hamada rightly advocate, would be sufficient and appropriate.

Here is much more (FT).  You will note that Posen is in general famous for being an advocate of stimulus for the UK and he is no enemy of Keynesianism or aggregate demand analysis.


The problem is, it doesn't seem monetary easing by itself can kickstart an economy. Japanese Debt is denominated in JPY, which adds some sense of security (i.e. it is unlikely for Japan to default). More importantly, unlike the US, very little debt is held by foreign government.

I think sensible fiscal expansion is needed to compound an inflationary moves by the Bank (or Abe, really). Monetary easing + fiscal tightening results in UK. Monetary easing + weak fiscal stimulus results in the US.

Japan in is in a position to kickstart its economy with a sharp stimulus. However, I agree that there is a very damning structural aspect to Japanese debt in terms of an aging population. Long term deficit-reduction is, then, very important.

I'm not Keynesian, but I do believe in EMH. How do you explain the massive rise in the Nikkei since Abe announced his stimulative platform? Whatever he's doing, the markets seem to like it.

As eggertsson has argued increased fiscal spending can act as a commitment device for the BoJ to commit to higher inflation.

Although I still agree with this analysis that Japan's problems are more demographic than anything else.

Before taking a view on the yen, I would suggest you ask yourself the following questions/take the following into account

1 JGBs
The Budget deficit is running at approx 8% of GDP but the government has said that it will expand this in the short term.
If bond rates rise to 2.75% they will account for 72% of tax revenues in 2020 so a bond rate sell off must be prevented
In a typical year approx 1.5-2x net issuance or 12-16% of GDP changes hands
The major government sponsored institutions are dissaving as assets shrink, as are households, private institutions are holding their positions flat and the banks are reducing their exposure.
NB as the equities start to rise, presumably the private sector will react to this.

As buyers of last resort this means the BOJ could be in the market for conservatively between 5-10% of GDP every year whereas in the past your net purchases have been minimal.- NB dont be fooled by them talking about gross purchases
Furthermore in the past the BOJ has offset those purchases by reducing their repo collateral so keeping a reasonably stable balance sheet.
At the current rate they will run out of collateral at Easter 2013, from then on any net purchases will lead to balance sheet expansion at about 5-10% pa compound

They then have two realistic options
1) Neutralise via FX sales so hoping to stimulate exports but leading to imported inflation
2) Leave the new money in the Japanese economy leading to asset inflation

2 Devaluation
Given that the trade balance is flattish but approx 70% of imports are US$ priced, how much do you think Japan will benefit from a weaker currency?

3 Money printing
US and Euro have done approx 15% over 5 years, this devalued their currencies vs the yen approx 30%. What impact do you think say 8% compound will do to the yen?

4 Yen target
If 95 feels about right at what point will the BOJ intervene, 100, 120, 150?

5 Local Government debt
This is now approx US$2.6Trn or 25% of the JGB market and continues to expand rapidly according to the Local government bond asssociation. This suggests that local government finances are in disarray, so why is there so little commentary on this?
Will the BOJ buy their debt if funding costs start to rise?

6 Tax revenue as a % of GDP
Taxes as a % of GDP were approx 13% in 1990, 10% in 2000 - 10%, 8% in 2010. This was as actual tax rates were flat implying that the economy was becoming less profitable and or government involvement in GDP was increasing. Corporate and personal tax rates are already high vs the rest of the world and Japanese corporates actually pay full tax rates unlike corporates in the US.

Govt is targetting 9% in 2012 but this is due to tax hikes, How can taxes as a % of GDP can rise without substantial tax hikes? If taxes do rise what sort of impact due you expect this to have on GDP?

7 Flat GDP in 2020 vs Today
Given the fall in working population productivity will need to rise 1.3% compound just to keep GDP flat. There has not been continuous productivity expansion in Japan for five years since the early 1990s. Do you think you can achieve this enhancement as the average worker age rises?

8 Reform plan of 2011
a) Assumes consumption tax of approx 13% and reduced per capita public pension contributions - are these realistic assumptions?
b) Assumes interest rates of 3+% in 2020, at which point the government will be unable to cover interest payments
c) Assumes Social security costs will run at 2.2% cagr vs GDP at 1.75%

9 Spending changes since 2005
Local government, Education, Defense have fallen <5%, Social security is up 39%, Interest payments are up 40% despite falling rates. The only meaningful reduction has been public works which is set to grow again.

What do you think is possible going forward?

10 Interest costs
Central government interest costs circa 10.9Trn yen + local government at 0.7 = 11.7 Trn
National income
Corporates - listed at 2% profit margin =11.9
Unlisted - assume zero in aggregate
Households @ 2.5% savings rate = 21.7

Ie Japan has approx 10Trn Yen available to save per annum this is now less than net 35 Trn pa JGB issuance. How will the Japanese bridge the gap....

Personally I think there is now a good chance they will redenominate the currency within 5 years

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