Why Japan's Abenomics Won't Work
"Quantitative and qualitative monetary easing is expected not only to work through such transmission channels as long-term interest rates and asset prices, but also to lower real interest rates through a pickup in inflation expectations."
--Bank of Japan, semi-annual report
The Year Ahead 2018
The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.
In September, Japan voted the LDP, led by Shinzo Abe, into power. Abe and his LDP colleagues ran for office on a platform of reflation, promising to impose a 2% inflation target on the BoJ. This may sound like a modest goal to us gaijin, but 2% inflation for Japan is like Mount Everest. Japan’s CPI has remained flat for twenty years. In fact, Japan has never had a sustained 2% inflation rate; 2% has been a level experienced during transitions between higher inflation and deflation.
Japanese CPI has been flat for 20 years not because the BoJ desired it, but despite the BoJ’s efforts to fight deflation over that period. The BoJ has sought to fight deflation by following a zero interest rate policy or ZIRP for the past 12 years. The BOJ has been unsuccessfully fighting deflation at the zero-bound for over a decade. When criticized for deflation and stagnant GDP growth, the BoJ has said that it is doing all it can. In saying this, the BoJ has ignored a great body of academic literature by western economists such as Ben Bernanke, Paul Krugman, Ronald McKinnon, Barry Eichengreen, Scott Sumner and David Beckworth.
Eleven years ago, Ben Bernanke gave a speech in Tokyo in which explained to the BoJ in detail how to target inflation or, better yet, price levels. The BoJ studiously ignored Bernanke’s advice until the Abe government finally ordered it to adopt inflation targeting, or else. Abe appointed a compliant governor, Haruhiko Kuroda, and the BoJ’s board has duly voted to implement a 2% inflation target. The BoJ has pledged to grow the monetary base by Y60-70 trillion per annum until 2016 in order to achieve 2% inflation. That would represent monetary base growth of about 40% this year, equivalent to the Fed’s QE3.
Isn’t that a wonderful story? Bad guys lose, good guys win, and twenty years of economic stagnation is finally ended. As readers remember, I have been a skeptic of Abenomics since it was announced last year. This is because I don’t believe that either Mr. Abe nor Mr. Kuroda understands modern monetarist theory. This is because they are focused on inputs (QE) and not outputs (prices and/or the price level). They are trying to make the shower warmer by turning the spigot by one centimeter every five minutes, rather than by turning it as far as it needs to go to get hot. Even now, the BoJ’s board is debating whether the 2% target can be achieved by 2016; maybe it will take longer, they say. Maybe it will take forever.
First, let’s take a look at the current situation. Under Mr. Kuroda, the BOJ has finally begun to grow its balance sheet, from 0% growth a year ago to 17.5% now, and accelerating. That’s progress. However, the money supply is only growing at 2.1%, which is not nearly fast enough, and the CPI is falling. Maybe by 2017 or 2019 his policies will work.
Increments of Y60-70 trillion will not be enough to break expectations. No one knows what the “right number” is, anymore than the guy in the shower knows how far he will need to turn the spigot until it gets warm enough. You turn the spigot until it gets warm because you can’t wait three years to take your shower.
There is absolutely no doubt that any fiat-money central bank anywhere in the world can create inflation whenever it chooses. Inflation is always and everywhere a monetary phenomenon. Right now, the top prize-winner is the Central Bank of Venezuela, which is expected to generate over 30% inflation this year, although the dark horse is the Central Bank of Argentina, where the rate of inflation is a state secret. They have created inflation effortlessly; it hasn’t been difficult or time-consuming. It wasn’t a monumental task.
The traditional way that a central bank creates inflation is by monetizing the government’s deficit in classic Latin American style. Certainly that would a good start for the BoJ, to commit to buy all JGBs issued by the government going forward. That’s around Y40 trillion, but not nearly enough.
As I have written earlier, the BoJ needs to focus on prices or, more precisely, the price of something. They can’t drive up the price of the JGB any further, it’s already in the stratosphere. The dollar would be an excellent price target, except that the US won’t allow it. That leaves gold, the traditional instrument of monetary policy. The BoJ should announce a policy of raising the gold price in yen by 1% a month until the rate of inflation is sustained at a level of 2%, and to continue to buy gold in sufficient quantities to maintain 2% inflation.
Of course, the world price of gold would rise to some degree, an unintended consequence. But the gold price of the yen will fall, that is axiomatic, automatic, guaranteed. Yen will spew forth from the BoJ, expectations will be broken and the price level will rise. It’s been done many times before; Nixon did it in 1973 and got all the inflation he ever wanted.
Bloomberg: "The BOJ's inflation forecast is quite ambitious and probably pretty hard to achieve," said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance in Tokyo. "There's no guarantee that by expanding base money, the BOJ can heighten inflation expectations," he said. "It would be tough to achieve 2 percent inflation in Japan with monetary easing alone."
If Mr. Kodama is saying what I think he’s saying, then he agrees with me: incremental QE alone won’t heighten inflation expectations. To break Japanese inflation expectations will require a policy of shock and awe, which a gold price target policy would achieve.
Because the BoJ will never adopt a gold price target, its current QE policy will fail to achieve a sustained 2% rate of inflation in the foreseeable future.