Shinzo Abe is doing what many economists have been calling for in the US and Europe: a comprehensive programme entailing monetary, fiscal, and structural policie
Japanese prime minister Shinzo Abe’s programme for his country’s economic recovery has led to a surge in domestic confidence. But to what extent can “Abenomics” claim credit?
Interestingly, a closer look at Japan’s performance over the past decade suggests little reason for persistent bearish sentiment. Indeed, in terms of growth of output per employed worker, Japan has done quite well since the turn of the century. With a shrinking labour force, the standard estimate for Japan in 2012 – that is, before Abenomics – had output per employed worker growing by 3.08% year on year. That is considerably more robust than in the United States, where output per worker grew by just 0.37% last year, and much stronger than in Germany, where it shrank by 0.25%.
Nonetheless, as many Japanese rightly sense, Abenomics can only help the country’s recovery. Abe is doing what many economists (including me) have been calling for in the US and Europe: a comprehensive programme entailing monetary, fiscal, and structural policies. Abe likens this approach to holding three arrows – taken alone, each can be bent; taken together, none can.
The new governor of the Bank of Japan, Haruhiko Kuroda, comes with a wealth of experience gained in the finance ministry, and then as president of the Asian Development Bank. During the East Asia crisis of the late 1990s, he saw firsthand the failure of the conventional wisdom pushed by the US Treasury and the International Monetary Fund. Not wedded to central bankers’ obsolete doctrines, he has made a commitment to reverse Japan’s chronic deflation, setting an inflation target of 2%.
Deflation increases the real (inflation-adjusted) debt burden, as well as the real interest rate. Though there is little evidence of the importance of small changes in real interest rates, the effect of even mild deflation on real debt, year after year, can be significant.
Kuroda’s stance has already weakened the yen’s exchange rate, making Japanese goods more competitive. This simply reflects the reality of monetary policy interdependence: if the US Federal Reserve’s policy of so-called quantitative easing weakens the dollar, others have to respond to prevent undue appreciation of their currencies. Someday, we might achieve closer global monetary-policy coordination; for now, however, it made sense for Japan to respond, albeit belatedly, to developments elsewhere.
Monetary policy would have been more effective in the US had more attention been devoted to credit blockages – for example, many homeowners’ refinancing problems, even at lower interest rates, or small and medium-size enterprises’ lack of access to financing. Japan’s monetary policy, one hopes, will focus on such critical issues.
But Abe has two more arrows in his policy quiver. Critics who argue that fiscal stimulus in Japan failed in the past – leading only to squandered investment in useless infrastructure – make two mistakes. First, there is the counterfactual case: how would Japan’s economy have performed in the absence of fiscal stimulus? Given the magnitude of the contraction in credit supply following the financial crisis of the late 1990s, it is no surprise that government spending failed to restore growth. Matters would have been much worse without the spending; as it was, unemployment never surpassed 5.8%, and, in throes of the global financial crisis, it peaked at 5.5%. Second, anyone visiting Japan recognises the benefits of its infrastructure investments (America could learn a valuable lesson here).
The real challenge will be in designing the third arrow, what Abe refers to as “growth”. This includes policies aimed at restructuring the economy, improving productivity, and increasing labour-force participation, especially by women.
Some talk about “deregulation” – a word that has rightly fallen into disrepute following the global financial crisis. In fact, it would be a mistake for Japan to roll back its environmental regulations, or its health and safety regulations.
What is needed is the right regulation. In some areas, more active government involvement will be needed to ensure more effective competition. But many areas in which reform is needed, such as hiring practices, require change in private-sector conventions, not government regulations. Abe can only set the tone, not dictate outcomes. For example, he has asked firms to increase their workers’ wages, and many firms are planning to provide a larger bonus than usual at the end of the fiscal year in March.
Government efforts to increase productivity in the service sector probably will be particularly important. For example, Japan is in a good position to exploit synergies between an improved healthcare sector and its world-class manufacturing capabilities, in the development of medical instrumentation.
Family policies, together with changes in corporate labour practices, can reinforce changing mores, leading to greater (and more effective) female workforce participation. While Japanese students rank high in international comparisons, a widespread lack of command of English, the lingua franca of international commerce and science, puts Japan at a disadvantage in the global marketplace. Further investments in research and education are likely to pay high dividends.
There is every reason to believe that Japan’s strategy for rejuvenating its economy will succeed: the country benefits from strong institutions, has a well-educated labour force with superb technical skills and design sensibilities, and is located in the world’s most (only?) dynamic region. It suffers from less inequality than many advanced industrial countries (though more than Canada and the northern European countries), and it has had a longer-standing commitment to environment preservation.
If the comprehensive agenda that Abe has laid out is executed well, today’s growing confidence will be vindicated. Indeed, Japan could become one of the few rays of light in an otherwise gloomy advanced-country landscape.
The world must now pray that Japan’s plan comes off in what remains its second-biggest mature economy
David Cameron once demanded a “big bazooka” to solve the euro crisis. In the event, big enough blasts were fired to quieten market monsters, but never to finally silence them; lingering fear still haunts a continent. Japan’s very different crisis, however, has lingered for longer, for so long that it ought instead to be called a permanent stasis – since 1990 to be precise. Rock-bottom interest rates, a depressed yen, stimulus and austerity have all been tried in various combinations. The economy has disregarded the lot, remorselessly rolling from lukewarm recovery to fresh recession and back. But now Tokyo is letting rip with a new bazooka that is big by any standards.
In accordance with wishes of Prime Minister Shinzo Abe, the supposedly independent Bank of Japan has explained how it will pursue inflation. In an economy where falling prices have often been the norm, the stock of money will be doubled in 21 months, and the newly minted currency will be used in novel ways; specifically, to purchase government debt from – in the jargon – across the yield curve. Both elements represent a radical departure in their own right. Nothing on this scale has been tried before, not even when the world’s central bankers worked in panicked concert in 2008. And the whole world must now pray that the plan comes off in what remains its second-biggest mature economy: a recovered Japan really could boost a stagnant planet.
But is that likely? It can’t be ruled out. This was not, as some said, a crude invitation to competitive devaluation: Tokyo is less concerned with the price of yen than with prices in Japanese shops. Even if trading partners cheapen their currencies in reply, it may be no bad thing. During the 1930s, beggar-my-neighbour policies cancelled out in terms of export sales, but the cheapening of currencies nonetheless helped ease debt deflation.
Big bazookas are hard to control, and those wielding the weapon could shoot themselves in the foot. Japan needs to persuade its people that prices will rise, but if expectations of excessive inflation are stoked, investors could take fright, causing borrowing costs to rise. It is a risk, though not one that aggressive monetary expansion in the US or Britain has yet seen realised; besides, risks simply have to be run if the alternative is permanent stagnation.
The deepest doubts arise from Japanese demographics: the typical citizen is four years older even than in ageing Britain. The idea of cheap money is to persuade people to open their wallets, and spend their way to recovery, but in this sort of senior society, fear of inflation eating up pensions could convince people they need to save more and spend less. Let us hope not. Where Japan led, the world has followed since 2008. Fingers crossed that it can now lead the way to a solution.
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As it was never envisaged that any country would leave the euro, the effects of such an exit would be felt worldwide
Deadlines have been set. Ultimatums have been delivered. The EU has given Cyprus until Monday to come up with €5.8bn to part fund its own bailout or have its financial lifeline cut off by the European Central Bank.
Unthinkable less than a week ago, the possibility of the eurozone losing one of its 17 members is now being discussed. Reuters reported that a meeting of eurozone officials openly canvassed the need to impose capital controls to insulate the rest of the single-currency club in the event of Cyprus leaving.
It was never envisaged that any country would ever leave the euro. There is therefore no template for an exit strategy that would prove painful for Cyprus and have potentially wide-ranging implications not just for the rest of Europe, but for the whole global economy.
The first stage of the process would involve the EU calling Cyprus’s bluff. At the moment, Cypriot banks are being supported by the European Central Bank’s Emergency Liquidity Assistance, which allows them to remain open for business. The moment the ECB pulls the plug, Cyprus’s banks will go bust. They have a €17bn cash shortfall, no equity and could raise only perhaps €2bn from forcing bondholders to take a haircut. The banks would shut and deposits would be worthless.
Stage two would involve the government in Nicosia re-introducing the Cypriot pound as legal tender. This would cause logistical difficulties, unless the government has stashed away piles of the old currency when it joined the euro five years ago. This seems unlikely, so the government would have to start printing new notes.
This would take time to organise and in the meantime the government would have to use euro notes re-denominated as Cypriot pounds. One way of doing this would be to over-print the notes in a distinctive way, as happened in Germany during its currency crisis in the 1920s. Nick Parsons, head of strategy at National Australia Bank said the capital controls on withdrawals from cashpoints would make this process simpler, since there would be fewer euros in circulation when the crunch came.
The government would then have to set an exchange rate for the Cypriot pound against the dollar and would probably set it at the level that existed before it entered the single currency. If the currency was allowed to float freely on the foreign exchanges, the pound would drop like a stone. If the authorities set a fixed exchange rate, the official value of the currency would bear not the slightest resemblance to its black market value. When Argentina abandoned its convertibility against the dollar in 2002, the peso depreciated by around 75% in the subsequent 15 months.
A plunging currency would lead to dearer imports, rising inflation and sharp cuts in living standards. The government would impose strict capital controls to prevent money leaving the country. It would also try to ensure that all transactions in euros ceased. Unofficially, the euro – along with other hard currencies such as the dollar – would circulate on the black market.
One additional problem would be whether contracts agreed in euros could be enforced. The concept of lex monetae means debts in euros would become debts in Cypriot pounds and settled at an exchange rate decided by the government in Nicosia.
So what are chances of this happening? Parsons says it is still unlikely but the risk is far greater than it was. He writes: “A few months ago I would have put the possibility of Cyprus leaving the euro at 1%. Today I would put it at about 30%.”
Sales from overseas wind up being reduced once they are translated from weaker foreign currencies back into dollars. Exports also get pricier.
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Asian currencies continue to strengthen as uncertainty over the developments in Cyprus hurts the euro.
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Venezuela’s recent devaluation has excited predictions of an economic collapse. Luckily, such wishful thinking is ill-informed
Venezuela’s recent devaluation has sparked quite a bit of discussion in the international press. The Venezuelan opposition has naturally framed it as desperate move to head off inevitable economic collapse.
The opposition argument, supported by most of the international media (which relies on opposition sources), goes like this: Venezuela had to devalue because the government has run out of money. But the devaluation is too little and too late, inflation will get out of control, there will be more devaluations and more money will leave the country and the government will go broke and collapse.
Opponents of the Venezuelan government are hoping for an “inflation-devaluation” spiral that will help bring down the government. In this scenario, the devaluation raises the costs of imports, fueling inflation; with higher prices, the currency is more overvalued in real terms, and another devaluation follows, and so on. As people lose confidence in the currency, more people exchange their domestic currency for dollars, building more pressure for devaluation and causing the country to run out of foreign exchange reserves – a balance of payments crisis.
Of course, to the extent that the opposition can convince people that this is actually happening, it can help the process unfold – just as rumors of insolvency can cause a bank run. In both Venezuela and Argentina, the media is mostly opposition, and so it is not surprising that these views get prominent coverage in both countries.
Let’s examine the argument. The first premise – that Venezuela had to devalue in order to get more domestic currency (the bolivar fuerte) for each dollar of oil revenue – has been the foundation of most news reporting. But this does not make much economic sense. When the government devalues the currency from 4.3B to 6.3B per dollar, what does it do? It credits itself with two additional bolivares for each dollar of oil revenue that it receives.
Of course, it could create the same amount of money, without devaluing; opponents would object, “but creating money increases inflation.”
But the government’s creation of two additional bolivares for each dollar received is also creating money, no different from creating money without the devaluation. The main difference is that, in addition to any inflationary impact of creating more money, the devaluation also adds to inflation by raising the price of imported goods.
Creating money, though, does not always add to inflation. The US Federal Reserve has created more than $2tn since 2008, and inflation has not significantly increased. But if the Venezuelan government just wanted to have more bolivares to spend, it would be less inflationary to just create the money without the devaluation.
Why devalue, then?
Devaluation has other effects. Although more expensive imports add to inflation, they also help domestic production that competes with imports. And, perhaps more importantly, devaluation makes dollars more expensive, and therefore increases the cost of capital flight. This helps the government keep more dollars in the country.
Not surprisingly, a lot of what passes for analysis in the press is based on wrong numbers and flawed logic. The award for wrong numbers this time goes to Moisés Naím, who writes in the Financial Times that “during Hugo Chávez’s presidency, the bolivar has been devalued by 992%.”
Fans of arithmetic will note immediately that this is impossible. The most that a currency could be devalued is 100%, at which point it would exchange for zero dollars. Apparently, a very wide range of exaggeration is permissible when writing about Venezuela, so long as it is negative.
But, for a number of reasons, inflation-devaluation spirals in Latin America are a thing of the past – and a devaluation every few years is a far cry from such a spiral. In fact, despite press reports that inflation would reach 60% after the January 2010 devaluation – which was larger than the latest one – core inflation did not even rise, and headline inflation rose only temporarily. Inflation then fell for more than two years, even as economic growth accelerated to 5.2% last year.
The amount of inflation that follows this devaluation will depend on what other measures that the government takes and how effectively they are implemented: price controls, the provision of dollars for importers (including food), and capital controls. But if the past few years are any indication, the government will do what it needs to do in order to keep inflation and shortages from getting out of hand.
As for Venezuela’s public debt, the government is a long way from having a problem of unsustainable debt. The IMF projects Venezuela’s gross public debt for 2012 at 51.3% of GDP (as compared to more than 90% for Europe). A better measure is the burden of the foreign part of this debt, which in 2012 was about 1% of GDP, or 4.1% of Venezuela’s export earnings.
There are a number of distortions and problems with Venezuela’s economy – including recurrent shortages – and some of them have to do with the management of the exchange rate system. But none of these problems presents a systemic threat to the economy, in the way that – for example – real estate bubbles in the US, UK, Spain and other countries did in 2006. Those were truly unsustainable imbalances that made an economic collapse inevitable.
Despite the wishful thinking that is over-represented in the media, Venezuela’s economy will most likely grow for many years to come, so long as the government continues to support growth and employment.