Did the US cause the Great Japanese deflation?
Commenter Jim Glass provided another Paul Krugman op ed, this one from 2001 2011:
Nonetheless, Mr. Koizumi is right about one thing: Japan cannot go on like this. Swelling public debt will eventually threaten the government’s solvency; the festering financial problems of the banks will soon require a government bailout that will swell that debt even further. Something must be done. But the actions Mr. Koizumi has proposed could tip Japan into full-blown depression.
There is an answer to this dilemma, one that has become almost orthodoxy among economists who have tried to think seriously about Japan’s plight. This answer involves unconventional monetary expansion, with the Bank of Japan buying dollars, euros and long-term government bonds; it also involves accepting and indeed promoting mild inflation and a weak yen. I could explain why this would probably work, but what’s the point? It’s not about to happen.
For the real tragedy right now is that however innovative and open-minded Mr. Koizumi may be, he will fail unless other important players — mainly the Bank of Japan, but also the U.S. Treasury Department — are prepared to learn from Andrew Mellon’s mistake. And all the evidence is that they are not. The head of the Bank of Japan insists that the country’s continuing slump is the result of inadequate reform — that is, insufficient purging of the rottenness. And although the details are in dispute, the U.S. Treasury secretary, Paul O’Neill, appears to have warned Japan not to let the yen weaken too much.
Poor Japan. It is the victim of those who refuse to learn from the past, and thereby condemn others to repeat it.
So even three years after the famous 1998 liquidity trap paper, Krugman was still favoring monetary stimulus over fiscal stimulus for countries at the zero bound. But I’d like to focus on the comment regarding our Treasury officials. Krugman’s right that they have consistently warned the Japanese not to engage in “currency manipulation”. What our Treasury doesn’t understand is that all central banks manipulate currencies—-that’s their job! The only question is how. And don’t say “It’s OK to manipulate the purchasing power of a currency but not the foreign exchange value.” If the manipulation is done via central bank policy, then the two types of manipulation are identical. For decades, the US Treasury has been (unknowingly) warning the Japanese not to manipulate their economy out of deflation.
Ironically, a healthier Japanese economy would also be good for the US, boosting our exports and creating good jobs. Pity that we are so dense.
PS. Over at Econlog you’ll find a Trump post that is perhaps a bit less “unhinged” than usual. At least I hope so.
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8. April 2017 at 10:34
One typo in the first row: it’s from 2001, not 2011.
8. April 2017 at 10:50
“So even three years after the famous 1998 liquidity trap paper, Krugman was still favoring monetary stimulus over fiscal stimulus for countries at the zero bound.”
Maybe, when asked the question, Paul Krugman would still favour monetary stimulus over fiscal stimulus – even at the ZLB.
Perhaps he just shifted the focus of his advocacy from calling for monetary expansion to calling for fiscal expansion because he saw that the kind of non-conventional monetary policy involving a commitment to more expansionary monetary policy in the future (i.e. the first best solution at the ZLB) he argued for in 1998 was not within the mandate of the Bank of Japan and (more importantly) that this mandate / monetary policy regime would not change within the foreseeable future.
8. April 2017 at 11:03
Ok, I have to amend my comment from above. When asked the question today, Krugman would definitely (not just maybe) favour monetary stimulus over fiscal stimulus at the ZLB.
Here’s Krugman in 2009 explicitly calling monetary stimulus the “first-best” solution and fiscal stimulus the “second-best” solution:
“We’re in a liquidity trap, with interest rates up against the zero bound. This means that conventional monetary policy isn’t sufficient. What should we do?
The first-best answer — that is, the answer that economic models, like my old Japan’s trap analysis, suggest would be optimal — would be to credibly commit to higher inflation, so as to reduce real interest rates. […]
So some readers have asked why I’m not making the same arguments for America now that I was making for Japan a decade ago. The answer is that I don’t think I’ll get anywhere, at least not until or unless the slump goes on for a long time.
OK, so what’s next? The second-best answer would be a really big fiscal expansion, sufficient to mostly close the output gap.”
Here’s the link to the post:
https://krugman.blogs.nytimes.com/2009/11/13/its-the-stupidity-economy/comment-page-4/
8. April 2017 at 11:30
Am I banned?
8. April 2017 at 11:33
Yeah; the President is too incompetent and establishment-controlled to live.
Also, I do not believe this theory; what other central bank has behaved this way in response to U.S. complaints about currency cheapening?
Why has the real exchange rate of the Yen depreciated so much since the 1990s, anyway?
8. April 2017 at 17:42
Scott,
Insightful post. I would think about it this way.
1. In the short term, FX rates are driven by capital flows not by trade flows.
2. If the BoJ buys domestic assets (e.g. JGBs), it pushes up the price and reduces the supply of those assets. This makes foreign assets more attractive relative to Japanese assets, which causes investors to sell yen to buy foreign assets. (This is what causes the yen to weaken against foreign currencies.)
3. The increase in demand for foreign assets creates the same effect as if the Fed had purchased U.S assets. Ditto for Europe and the ECB, etc. So domestic Japanese monetary stimulus also has a stimulative effect throughout the world economy.
4. The extent to which domestic monetary stimulus will ripple out to the world economy in this way depends on the elasticity of the supply of domestic (Japanese) assets. In Japan supply side issues (taxes, regs, etc.) are so severe that the supply elasticity of assets is very low, and therefore monetary stimulus has little impact on the creation of new domestic assets. So investors who have sold Japanese domestic assets are unable to replace them with new Japanese assets and therefore largely replace those assets with foreign assets.
5. Thus the immediate effect of Japanese monetary stimulus is primarily on fx rates and in foreign countries. The benefit to Japan may largely be through the lagged effect of fx on trade.
8. April 2017 at 21:38
Scott,
Two other points to make, of which I’m sure you’re aware.
1. The only difference between direct “currency manipulation” and “manipulation” through monetary policy is that in one case the central bank buys foreign assets directly, and in the other case the purchase of foreign assets is effected through intermediary financial institutions.
2. With efficient, liquid, and unregulated capital markets; from the point of view of monetary policy it makes zero difference whether the BOJ buys US Treasuries or JGBs when they do OMP. Financial institutions/investors will replace the purchased assets with new assets. In an efficient market, OMP will result in the creation of x dollars of new US assets and y yen of new Japanese assets regardless of whether it was an OMP of Treasuries or JGBs. The new assets created will be the ones that have the highest (risk adjusted) return, and the returns on those new assets are largely independent on what assets the CB bought or from whom they bought. them.
8. April 2017 at 22:12
My understanding is that the Fed is not allowed to sell US dollars for foreign currency (or the opposite) with the express purpose of altering foreign exchange rates. As in exchange rate manipulation is not a monetary policy option here. At least by the Fed.
9. April 2017 at 00:17
An ‘experts’ view on the Japanese economy?
Prof. R.A.Werner, ‘Princes of the Yen’.
and/or
Prof. R.A.Werner, (2005), New Paradigm in Macroeconomics.
9. April 2017 at 00:29
Nice post.
Still, one glaring omission: The Bank of Japan has been buying back Japanese Government Bonds (JGBs) at a prolific rate. The BoJ will own the bulk the Japan’s national debt in some not-too-distant future.
So is Japan over-indebted? Or soon to be debt-free?
Adair Turner suggests the latter. The BoJ will own the bonds, and some fancy talk will ensure, and accountants will quiver and shake and chant, and the bonds will be retired. It doesn’t really matter, the bonds pay out and the money comes back to the government.
This is over-indebted? Where do I sign up to become over-indebted?
You would think the way macroeconomists talk, there are laws of physics involved, that is it impossible to pay off government debt by printing (digitizing) money.
Well, except it is being done.
Another option for Japan is helicopter drops (although some say QE plus deficit spending is helicopter drops).
Nice headline:
Bloomberg
Tokyo Has More Than Two Job Openings for Every Applicant
by Shoko Oda and Isabel Reynolds
March 17, 2560 BE (2017 AD) 3:00:00 AM GMT+07:00
So, labor shortages and deflation.
Notice the political stability in Japan, no elections of President Trump-a-sans.
A nation that wants stability should shoot for “labor shortages.”
9. April 2017 at 01:36
@Benjamin Cole
9. April 2017 at 03:56
Ben Cole,
I think you’re glossing over some things.
1. If the BOJ were to literally just destroy the bonds they purchased, that would presumably be highly inflationary.
2. Japan is obviously a much more homogeneous society than the US or UK, so domestic tranquility is easier in that sense.
3. Japan has paid a terrible price economically for their cultural/racial insularity. Japan’s GDP is much smaller than it would have been if they’d had a significantly more open immigration policy.
My sense is that many racists and cultural bigots fail to understand the economic costs of their bigotry.
Of course, I suppose that policies to encourage higher birth rates could also be pursued, to avoid surrendering some of the tranquility that comes with cultural or racial homogeneity, but it could be tough formulating such policies and the trade offs could be worse than those that come with more open immigration.
9. April 2017 at 04:17
@scott freelander
1. How would the BOJ destroy bonds???? Last time I checked they have liabilities on the balance sheet that don’t go away just because they’ve destroyed bonds.
2. Yep
3. Not sure I agree with that. Immigration is pretty open in Japan. It’s just that no one (or not many people) want to move there because the economy sucks.
Low birth rate is mostly a result of the bad economy…. not the other way around. Japan could juice the birth rate with radical tax cuts for families with children, but it will never happen. Politicians will just moan about the low birth rate and pass ridiculous useless measures that will have no impact.
9. April 2017 at 04:34
On my second point, I’m not saying it’s likely or feasible for the BOJ to simply cancel the Japanese government debt. I’m saying there’s no free lunch.
9. April 2017 at 05:21
Below Potential, Thanks for pointing out the typo, and also the 2009 Krugman post. I wonder if he still believes what he wrote in 2009. The Japanese did raise the inflation target to 2%—does he now oppose fiscal stimulus in Japan?
Harding, I’m not sure why the real value of the yen has fallen so much, I presume the global terms of trade have moved sharply against Japan. It faces competition from China in manufacturing, and has not been able to move past that with “Silicon Valley” companies like we have here.
dtoh, You said:
“The increase in demand for foreign assets creates the same effect as if the Fed had purchased U.S assets.”
Only if the Fed had purchased those assets with yen, not with dollars.
Ben, You said:
“Nice headline:
Bloomberg
Tokyo Has More Than Two Job Openings for Every Applicant”
Interesting that you don’t believe those headlines when applied to the US.
dtoh, You said:
“Low birth rate is mostly a result of the bad economy….”
Actually that’s not true, it’s fallen just as much in all the other advanced East Asian economies, which are mostly booming. And the Japanese birthrate was much higher in the 1950s when Japan was poor. If anything, it’s affluence which has depressed the birthrate.
9. April 2017 at 05:27
Can’t stand dissent eh Sumner? Join the complacent class.
9. April 2017 at 06:24
Scott Sumner:
Japan, well I suppose some headlines are accurate and others are not.
In Japan, the number of job opening does excess the number of job-hunters.
“Jobless rate hits 22-year low of 2.8% in February
5:34 am, April 01, 2017
Jiji Press
TOKYO (Jiji Press) — The seasonally adjusted jobless rate in February fell 0.2 percentage points from the previous month to 2.8 percent, the lowest level since June 1994, when the rate stood at the same level, the Internal Affairs and Communications Ministry said Friday.
The jobless rate posted a reading below 3 percent for the first time in December 1994, the ministry said. It dropped for the second straight month.
“The employment situation is steadily improving,” a ministry official said. Job offers are increasing on the back of labor shortages, thus benefiting people who are trying to find jobs, the official noted.
Separately, the Health, Labor and Welfare Ministry said the ratio of job openings to job seekers in February came to 1.43 after seasonal adjustment, unchanged from January. It stood at the level for three months in a row.”
—30—
Scott Sumner: Should you be researching why a large developed nation can have 2.8% unemployment, a large QE program, and no inflation? Why are rents falling in Tokyo, which is a growing city?
Are there insights to be gained?
Japan runs a trade surplus, and has no house price explosion. Is that a positive or a negative? Seems positive to me.
Tokyo is considered by many the most livable big city in the world for its employment opportunities, safety, and affordability.
9. April 2017 at 09:54
Scott,
You said, “Only if the Fed had purchased those assets with yen, not with dollars.”
Not sure I agree. Can you elaborate.
9. April 2017 at 10:04
@benjamin cole
Labor situation has not really changed much in Japan. Drop in unemployment offset by the lower LFPR. The only thing that is really going on is less hours worked and a shift to part time work.
The real problems in Japan are a lack of growth and the political difficulty of reallocating resources as the population ages.
9. April 2017 at 13:15
The yen can never depreciate!
https://thefaintofheart.wordpress.com/2016/05/19/central-bankers-are-always-in-a-permanent-state-of-readiness/
9. April 2017 at 15:57
Dtoh: I agree Japan should be more aggressive in seeking growth. Helicopter drops.
My real point is the US should too.
And the war on labor, through the targeting of high unemployment rates is foul and atavistic.
Also, property zoning needs to become a part of the macroeconomic discussion.
9. April 2017 at 18:22
@BC
Seek growth – Yes
Helicopter drops – No
Reduced tax rates on capital – Yes
War on labor – ??????
Property zoning changes – No
Change structure of property taxes – Yes
10. April 2017 at 00:28
“Interesting that you don’t believe those headlines when applied to the US.”
Evidence that the US labour market is below full employment?
“More evidence that the US labour market is not at full employment”
http://bilbo.economicoutlook.net/blog/?p=35629
“Even more evidence that the US labour market is below full employment”
http://bilbo.economicoutlook.net/blog/?p=35657#more-35657
10. April 2017 at 00:53
“In 1985, the Plaza Accord was signed, and a report named after former Bank of Japan Governor Haruo Maekawa was published. This report includes in it proposals for structural reforms that the current Koizumi Administration is intent on carrying out today.
But in order to realise these proposals, it was understood there would be much opposition from current power groups with vested interests. The author believes that the Bank of Japan elite chose the creation of the bubble and the consequent deep recession as the means to overcome this opposition.
A Bank of Japan-bred elite ‘prince’ and Ministry of Finance officials have taken turns in occupying the seat of Governor of the Bank of Japan. Yet the latter are apparently mere puppets and when a MoF man is acting as Governor, there is without fail a Bank of Japan elite member under him acting as Deputy Governor but who holds the real authority. What’s more, MoF-born Governors are removed from the decision-making process of that vital policy tool, window guidance.”
http://www.profitresearch.com/e/press/media_quotes/media_english/ebook_denki_01june13.htm
10. April 2017 at 07:08
Scott, will there be a post about this?
https://iea.org.uk/did-the-federal-reserve-cause-trump/#.WOsu_VYm15A.twitter
10. April 2017 at 08:42
https://krugman.blogs.nytimes.com/2011/03/18/credibility-and-monetary-policy-in-a-liquidity-trap-wonkish/?_r=0
Here’s Krugman in 2011 saying that idealy you need the bank to credibly promise to be irresponsible, but it just hasn’t happened:
“On a personal note: I supported fiscal expansion in 2008-2009 precisely because I didn’t believe that the kind of commitment-based unorthodox monetary policy that works in the models could, in fact, be implemented in practice. Nothing I’ve seen since has changed my views on that subject.”
I for one think that there is some combonation of unconventional policy that could get the job done, be it NGDP futures or minting the coin, but nobody has had the guts to do it. So, fiscal it is then
10. April 2017 at 12:45
Ben, You said:
“Should you be researching why a large developed nation can have 2.8% unemployment, a large QE program, and no inflation?”
1. It has a low natural rate of unemployment.
2. Money demand is high due to a low opportunity cost of holding money.
Anything else you want to know?
dtoh, When Japan buys T-bonds it does so with yen. When the Fed buys T-bonds it does so with dollars. Those two policies have very different effects.
Ben, You said:
“Dtoh: I agree Japan should be more aggressive in seeking growth. Helicopter drops.”
Isn’t that what they’ve been doing for decades?
Kevin, Thanks, I’ll probably do one at Econlog tomorrow.
Austin, Where I differ from Krugman is that I think it’s actually easier to get central banks to do unconventional things than it is to get Congress to do fiscal stimulus. In addition, the Fed would likely offset the impact of fiscal stimulus (as they offset the austerity of 2013.)
10. April 2017 at 15:33
The BoJ will own the bulk the Japan’s national debt in some not-too-distant future. So is Japan over-indebted? Or soon to be debt-free?
I think ssumner made a post about this issue some months ago. When I remember correctly not paying pack the bonds will be (highly) inflationary.
A similar interesting question might be: What happens when the corporate bonds the ECB is buying so much will lose value or become even worthless?
10. April 2017 at 19:32
Scott,
You said; “dtoh, When Japan buys T-bonds it does so with yen. When the Fed buys T-bonds it does so with dollars. Those two policies have very different effects.”
That’s where I thought you were going. You think it’s very different because you believe the transmission mechanism for monetary policy is base creation (hot potato).
I think the transmission mechanism is credit (financial asset) creation so I disagree. When the BoJ buys T-bonds it creates new credit (whoever sold the bonds buys new assets) and you get NDGPD growth acceleration with no base increase….just a base velocity increase.
If the Fed forces Chase to lower lending rates by 100BP, do you get an NGDP increase? Do you get an increase in the base?
10. April 2017 at 19:49
Scott Sumner re Japan:
Helicopter drops in Japan?
Well, maybe. Deficit spending is not a helicopter drop, unless accompanied by concurrent QE, in my opinion.
So, Japan may have been doing helicopter drops for the last several years, and it has been working. They need to be more aggressive.
I would prefer Japan be upfront about it, and that the BoJ and national government dispense with the issuing of debt, and simply go direct to helicopter drops, preferably by cutting taxes, not by building bridges to remote islands.
Tax cuts financed by money-printing.
Indeed, such helicopter drops are probably a good idea in the US also.
BTW, the Fed’s Labor Markets Conditions Index came out yesterday. Lower from February, part of a trend to softer labor markets since 2010.
So, we have the prospect of a Fed raising rates when inflation is below target, labor markets are soft, global supply lines glutted, and economic growth has been subpar since 2008.
10. April 2017 at 20:12
dtoh, there a few things I don’t understand. How can the Fed ‘force’ Chase to lower its lending rates for one thing? Chase is not going to lend unless it thinks it will get paid back, and it will want to make money on that whole transaction. I don’t see how the Fed can ‘force’ them to loan for less than they want to.
Also- assuming US T-bonds- aren’t all US T-bond purchases made in US dollars? Doesn’t matter if it foreign central bank.
10. April 2017 at 20:48
@Jerry Brown
Re Chase, it’s a theoretical question. That said, I believe monetary policy could be effected by allowing the FED to dynamically set maximum and MINIMUM asset/equity ratios for banks. By raising the minimum, the Fed could force the banks to buy assets (i.e. make loans.)
Re T-bonds. Yes you’re correct, and strictly speaking Scott is incorrect. Normally a CB would convert yen into dollars to buy the T-bonds. If we want to be really picayune though, it’s certainly possible to settle a Treasury trade with payment in yen. Scott’s point however is not about the settlement currency, it is that there is no net creation of (base money) dollars when the BoJ buys T-bonds.
11. April 2017 at 03:50
I think the transmission mechanism is credit (financial asset) creation
The FED, the BOJ and the ECB seem to think this as well. I never heard someone like Draghi, Kuroda or Yellen talk about the transmission mechanism ssummer likes to talk about. It seems to me that this mechanism doesn’t really exist in their minds, but they do talk about credit all the time.
11. April 2017 at 06:21
@christian
My sense is that the CBs think about the quantity of money and the price of credit. I don’t think they think about the quantity of financial assets (e.g. credit) very much.
11. April 2017 at 14:33
dtoh, If that were true (and it isn’t) then fiscal policy would be more powerful than monetary policy.
Ben, You said:
“Deficit spending is not a helicopter drop, unless accompanied by concurrent QE”
It was.
11. April 2017 at 15:00
@Dtoh
“price of credit. I don’t think they think about the quantity of financial assets (e.g. credit)”
I don’t see the huge difference in this. Draghi loves to talk about credit creation and that there needs to be more of it.
In one of the last statements of the ECB from March they talk about inflation and prices, too. But from what I see it’s always interest rates and credit creation first. And then maybe (if we are lucky) inflation and prices.
11. April 2017 at 17:35
Scott,
You said; “If that were true (and it isn’t) then fiscal policy would be more powerful than monetary policy.”
If we ignore the impact on expectations, then In terms of adding labor input to the economy, yes….fiscal is just as effective as monetary policy.
The big difference is that monetary policy causes credit to be allocated efficiently through market mechanisms so you get investments that actually raise productivity instead of building roads to nowhere. As a result you get a boost in long term growth rates not just a one time bump from having more hours worked.
(Obviously if fiscal policy is implemented through tax cuts that’s different than if it’s through government spending.)
12. April 2017 at 00:06
“I think the transmission mechanism is credit (financial asset) creation”
“Werner-Proposal of 2011 (and 1996)
. . . Bank credit growth needs to expand and banks need a safe way to expand their business and their returns
. . . From the credit model we know that the proposal will boost nominal GDP growth – and avoid crowding out from the bond markets. This increases employment and tax revenues. It can push countries back from the brink of a deflationary and contractionary downward spiral into a positive cycle of growth, greater tax revenues and falling debt/GDP. “
https://www.postkeynesian.net/downloads/Werner/RW301012PPT.pdf
12. April 2017 at 00:11
“2. Money demand is high due to a low opportunity cost of holding money.”
By how much has ‘money demand’ increased since, say, 2007?
What was the opportunity cost of holding money in 2007?
12. April 2017 at 00:14
“Towards a New Research Programme on ‘Banking and the Economy’ –
Implications of the Quantity Theory of Credit for the Prevention and Resolution of Banking and Debt Crises”
https://eprints.soton.ac.uk/339271/1/Werner_IRFA_QTC_2012.pdf
12. April 2017 at 13:37
dtoh, The big difference is that money is the medium of account and hence it’s value is extremely important. That’s not true of other asset prices. Money is special.
Postkey, Money demand rose about fourfold and the op. cost of holding money fell from about 5% to roughly zero.
12. April 2017 at 13:59
Scott,
You said, “The big difference is that money is the medium of account and hence it’s value is extremely important. That’s not true of other asset prices. Money is special.”
So that’s not where I thought you were going with your answer, but is something I’ve thinking about the last couple of days based on your post.
I have two questions (not rhetorical I actually don’t know the answers.)
1. How important is the quantity of the medium of account.
2. Does the medium of account ever need to be held outside of the banking system (i.e. by the public at large.)
13. April 2017 at 00:02
“Postkey, Money demand rose about fourfold and the op. cost of holding money fell from about 5% to roughly zero.”
Thanks for your reply.
13. April 2017 at 14:45
dtoh, The value of the medium of account is determined by changes in its supply and demand. So the quantity is important, with the proviso that if you are targeting inflation then the quantity will not correlate with the price level, because the quantity will be adjusted to accommodate changes in money demand.
It’s theoretically possible for the entire medium of account to be held within the banking system.
14. April 2017 at 16:04
Scott,
Sorry to keep this post alive, but I’m kind of curious about this as I think it sheds some light on our current monetary system. So thinking aloud.
1. Assuming you have a medium account limited to the banking sector and used primarily for interbank settlements and to insure banking liquidity.
2. Wouldn’t it be possible to expand the broader monetary supply simply by reducing the MOA reserve requirement as long as you preserved liquidity by some other means (e.g. an MOA credit facility.)
3. So it seems you could have price inflation (or deflation if you wanted) of goods and services with no change in the quantity of MOA.
4. Reserves also serve to preserve bank solvency (different than liquidity), but this could also be done by other means (e.g. bank capital ratio.)
5. Theoretically the MOA could just be fractional shares in a single shell bracelet held in a Fed vault.
So it seems to me that from a inflation/NGDP perspective the quantity of the MOA is only important to the extent that it controls the quantity of MOE.
Did I miss something or is this basically correct?
14. April 2017 at 17:15
dtoh, That’s debatable. If the MOE is also a medium of account, then monetary economics can be based on modeling either. The question is which perspective is the most useful. A good example of that distinction is my Great Depression book, where I felt a MOA approach (gold) was more useful than a MOE account approach (money).
14. April 2017 at 22:19
Ok. I’ll read the book and the you can explain it to me the next time I see you.
BTW – Doesn’t my example assume that the MOA is not used as a MOE because its use is limited to within the banking system.