On June 29, 2012, I posted “Future Heroes of Humanity and Heroes of Japan,” advocating just the sort of massive asset purchases the Bank of Japan has undertaken. Although I now think that using deep negative interest rates after eliminating the zero lower bound is a far superior policy, I am still interested to see how well massive quantitative easing has worked.
Japan’s GDP shrank by .4% in the 2d quarter of 2015. It is now slightly below the level it had in the first quarter of 2008, although with the shrinking of the Japanese population, per capita GDP is up about 1% since the first quarter of 2008. Overall, Japan has managed to clamber back up from blows of the Great Recession, but can it achieve sustained, robust economic growth?
Japan's Real GDP
The remarkable Japanese election in December 2012 put Prime Minister Shinzo Abe in charge, and induced a major change in monetary policy, as the Bank of Japan under Governor Haruhiko Kuroda embarked on a program of quantitative easing on steroids, committing to buying bonds and other securities equal in value to over half of GDP every year.
Prices of Key Components of Japan’s GDP
“Abenomics” seems to have had an effect. One of the key objectives for monetary policy has been to turn deflation into inflation of 2%. The quarter before Abe’s election was the low point for prices. Since the third quarter of 2012, consumption prices (blue), house construction prices (red) and business investment prices (green) have been on an upward track. Both the consumption prices and residential investment prices have a big jump up between the first and second quarter of 2014 due to Japan’s big sales tax increase. That jump due to the sales tax increase says nothing about whether or not monetary policy is working, so the upward trend in consumption prices is quite unimpressive. But because business spending is exempt from sales taxes, the business investment prices are unaffected by the sales tax increase; business investment prices show a steady increase since Abe was elected.
The steady increase in business investment prices, and volatile upward trend of house construction prices are important because the reason Japan wants to have more inflation is that when businesses build a factor or buy a machine, or someone builds a house, they are comparing the interest rate they have to pay to how fast the value of their investment or house will go up with time—of which inflation is an important component. And the price trends that matter for such investment decisions are the price trends for residential investment and business investment. (Indeed, Bob Barsky, Chris Boehm, Chris House and I have an early stage working paper arguing that for this reason central banks should pay much more attention to investment goods prices than they do.)
One way of seeing how well Japan has turned around its price trends is look at Japanese inflation compared to US inflation. In the graph below, a flat line would mean that Japanese inflation was equal to US inflation. Even after correcting for the sales tax increase, since Prime Minister Abe’s election late in 2012, inflation for consumption and business investment don’t look that different in Japan than in the US, and the lower inflation for residential investment reflects relatively high inflation for that component of GDP in the US rather than a lack of inflation in Japan.
Japanese Price Trends Compared to US Price Trends
Japan’s Performance is Still Substandard. So far, this sounds like a rosy picture. But it isn’t. A stagnant economy is a bad outcome. And even if Japan’s current inflation trends continue, they still don’t make a zero interest rate low enough in comparison to set off the investment boom that is needed to jump-start the Japanese economy. After all, the US inflation statistics used as a point of reference for Japan’s above don’t give the Fed that much room to maneuver under current policy parameters either.
How Japan Can Get Out of Its Bind. What Japan needs is an even more dramatic shift in its monetary policy: deep negative interest rates.
In a recent Quartz column, I talk about the growing acceptance of the idea that the so-called “zero lower bound” or “effective lower bound” on interest rates can be eliminated. In particular, a time-varying paper currency deposit fee on net deposits at the cash window of a central bank can make it possible to cut interest rates as low as needed, without having to worry about people hoarding paper currency. The secret is that the central bank is promising to convert money in the bank into more and more paper currency in the future—at a more than 1-for-1 exchange rate, so storing cash is a worse deal than taking a negative interest rate in the bank but then being able to convert those funds into cash at a favorable exchange rate in the future. If interest rates later turn positive, this process can be reversed, or if necessary, it can go on indefinitely. I have personally visited central banks all over the world explaining such an approach, and take care to explain to central bank staffers and decision-makers how smoothly this can work.
When I visited the Bank of Japan in June 2013 to explain how to eliminate the zero lower bound on interest rates and use deep negative rates to revive the Japanese economy, the Bank of Japan wasn’t ready. Given the partial success that they have had with massive quantitative easing, and the dramatic election results it took to get to that far, I still don’t think don’t think the Bank of Japan is ready for deep negative interest rates. But that is the first step on Japan’s road back to a vibrant economy.