Don't Shoot the Messenger

The A-b-e Of Economics

And the world said “Let Shinzo Abe be”, and all was light.

A new craze is sweeping the planet. Known by the title “Abenomics” over the last couple of years it has been steadily gathering adepts in financial markets across the globe. Despite the fact Abe’s move fits comfortably within the austerity vs growth policy axis, at the heart of the new approach lies not a strategy to directly create growth per se, but rather one to try to induce inflation. For those who have not been following the Japan saga as it has developed over the last twenty odd years this whole debate may seem like a strange way of thinking about things. After all isn’t inflation supposed to be a bad thing, one central banks are supposed to combat? And how can a country possibly become more ever more competitive by force-feeding itself inflation?

Of course, falling prices are not necessarily in-and-of themselves a bad thing – as any old consumer will tell you – since products get cheaper and cheaper with each passing day. So the run of the mill consumer might find life in Japan quite a pleasing and desirable thing, especially if that particular consumer happens to be retired and living on a fixed income derived from savings as indeed many contemporary Japanese actually are. Falling prices only really become a problem in a more general macroeconomic sense if they lead people to postpone consumption, and if this postponement becomes self-perpetuating in a way which leads prices to continually fall, as the combination of constant productivity increases and stagnant demand serve to produce perpetual oversupply. Falling prices also represent a nasty headache for policymakers since while prices go down the value of accumulated debt doesn’t, and herein lies the rub. So additional “stimulus” which doesn’t lead to increasing nominal GDP simply pushes the sovereign debt even farther along an unsustainable trajectory.

As everyone now recognizes and accepts Japan has a rapidly ageing population and an ageing and contracting workforce. This is the end result of several decades of very low fertility. The number of children in Japan fell to a new low in 2013, while the amount of people over 65 has reached a record high as the population ages and shrinks. This demographic background, which has really been obvious to demographers for years, has only lately come to be regarded as a significant factor in the “Japan problem” by economists. This neglect has most probably been due to the influence of a deep seated predisposition among adherents of neoclassical growth theory to think that population dynamics don’t fundamentally influence economic performance in the long run. For many years the Japan phenomenon was simply seen as a classic example of what Richard Koo terms a “balance sheet recession” wherein the need for the private sector to deleverage from excessive indebtedness leads to a form of structural under-consumption.

Perhaps the most important thing which the whole Abenomics episode has brought to light is the urgent need to bring the existing corpus of economic theory somehow up to date with our modern realities. Despite all the talk of policies for “growth, growth, growth” a simple look at the population outlook in OECD countries and especially the potential work force numbers suggests that, at some point or another, economic growth will turn broadly negative. So the real point is there is an experiment being conducted in Japan, but the experiment isn’t Abenomics (which I suspect won’t work, and could end badly). No, the experiment is about learning to grow old with dignity, not as individuals, but as societies. It is about managing debt in a time of deflation, about giving opportunities to the young, even while the force of the ballot box rides with the old, and about finding ways to ease that rate of work force decline to give some additional room to allow productivity to help, which means both immigration and helping the young – at they are the ones who start families.

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7 Responses to “The A-b-e Of Economics”

BurkMay 1st, 2013 at 8:49 pm

I missed one thing- the mechanism of how the BOJ is going to induce inflation. Who gets the newly printed money? Selling bonds (or buying them) does no one any good- it's all savings. The only way I see to induce inflation is fiscal spending. So the needed policy would seem to require coordination between the government and BOJ to increase spending (& deficits) even more, until savings desires are finally sated and consumption / aggregate demand rises. Is that correct?

It also seems that this is a very controllable process- spending is always controlled, and can be wound down when inflation gets to acceptable levels. So I don't see the big problem of "runaway", except for the currency speculation angle, which on the whole would seem to work towards stability, not against it, even if it weakens the policy effects.

Nimrod TechenMay 1st, 2013 at 9:29 pm

Our country can benefit if the average person understands cash flow, balance sheets, and value investing metrics.

TomMay 2nd, 2013 at 7:28 am

I'll admit I skimmed most of this, I don't quite have *that* much time on my hands. But I tend to agree, except that I'm less fond of Krugman. Japan isn't facing up to the reality that it needs to either allow immigration or to accept decline and try to make it as comfortable as possible. Instead Japan is trying to fight structural decline with countercyclical stimulus. The result will be an acceleration of debt growth, a small, one-off and temporary boost to growth (due to collapse if and when stimulus is withdrawn), and still no inflation. The excitement about Abenomics especially in the west is silly and embarrassing. Perhaps though it will help wake people up when in a year or two Japan is still struggling and the only idea Abe’s supporters will have is to cancel the planned fiscal consolidation and keep on with more of the same.

On the other hand I don’t see any debt crisis in Japan, as so much of the debt is owned by public institutions, including the central bank, which will be doing most of the buying for the foreseeable future. Cash will pile up in the Japanese financial system, and large foreign exchange reserves and income from Japan’s foreign investments will support the yen. The central bank will probably start buying FX assets to prevent appreciation, but the yen will likely creep back to the 80s vs the dollar within a year or two anyway. Outward FDI might pick up but I doubt “Mrs Watanabe” will invest much abroad. The biggest problem will be growing wealth disparity, though in Japan I think that will take a somewhat different form, of power being increasingly concentrated (even more) in corporations.

A SinclairMay 7th, 2013 at 10:13 pm

This policy will not work for Japan because they are heavily indebted and must roll over a huge amount of debt continually and the increased interest costs from inflation will destroy their finances. In fact they must issue more debt than the deficit as they are liquidating about $100 billion a year of JGB's in social security. Almost 60% of expected 2013 spending will be borrowed. The deficit is out of control. The Krugman approach of stimulus spending is what got them into this fix. Inflation is definitely not the answer as interest costs consume 23% of revenues now; if they are successful (2% inflation), interest costs will migrate to 3% or higher. That would consume 69% of revenues or more. It is easy to see there is no exit on this path. The weaker yen will give them some inflation, mostly for energy and food. This will act as a brake on other consumption instead of increasing it. There are a few big companies that are paying out larger bonuses but that will not help the average consumer, especially the retired individual. The only exit path for Japan is to downsize government and get more efficient. Failure to do this means that the government has wasted the massive savings of a very industrious and conservative people. The people have trusted the government and the funds are gone. The spending did not create growth but it did build debt. If I were in Japan, I would buy what I needed, then buy gold and then move the rest of my money into other currencies.

DiranMMay 8th, 2013 at 7:56 am

Thoughtful piece, but scary implications. So seeking investments to reflate Greek economy is hopeless because there is no demand that would make them pay off??? Further what to do about the debt overhang? More haircuts and restructuring on the horizon?

Finally, I do not believe that the ECB's policy is sufficient for a situation of 'beautiful deleveraging'. The economic divergences in the Eurozone are too large and sooner or later their will be a political upheaval that will lead to a partial break up of the system.

Added to this, is the serious long term issue of demographics in Europe, which is very similar to Japan.

BWildsMay 25th, 2013 at 1:45 pm

I feel Bernanke endorsed the move in Japan because he knew it would bolster world markets. The yen being dumped in the streets has quickly found its way out of Japan and into other parts of the world, areas like America and Germany.

This in effect takes pressure off the Bernanke QE effort, he does not have to do it all. I wonder how many secret currency swap deals are also being done to keep the wheels from falling off the currency markets. This will all end badly. They forget "true" demand drives investment as outlined in the post below,

cantuesoJune 28th, 2013 at 8:18 am

I am not surprised that Rajoy understood Krugman. His problem is not in understanding things, but in deciding, explaining, and acting. He likes to talk to small groups of 4 or 5 people, preferably inside an airplane. This setting can be photographed to generate the image of Rajoy decisive, explicit, and active.

Rajoy is a man of few words, all agree. However, for once now he had a great idea: he sent Soraya Saenz de Santamaría to sit beside Merkel on German TV. Her name alone reads like half a Rilke verse. And she looks so sweet and clever! And the ease and competence she shows in handling the jargon! The durchschnittliche=average Deutsche idea of Spain must have turned highly positive overnight.