Remember when then Bank of Japan last year initiated its unprecedented program of monetary easing most commentators saw that as an attempt to wage currency war to boost Japanese exports? I instead stressed that the “export channel” was not likely to be what would drag Japan out of the deflationary trap. Rather I stressed the importance of domestic demand.
This is what I said in May last year:
While I strongly believe that the policies being undertaken by the Bank of Japan at the moment are likely to significantly boost Japanese nominal GDP growth – and likely also real GDP growth in the near-term – I doubt that the main contribution to growth will come from exports. Instead I believe that we are likely to see a boost to domestic demand and that will be the main driver of growth. Yes, we are likely to see an improvement in Japanese export growth, but it is not really the most important channel for how monetary easing works.
I think that the way we should think about the weaker yen is as an indicator for monetary easing. Hence, when we are seeing the yen weaken, Japanese stock markets rallying and inflation expectations rising at the same time then it is pretty safe to assume that monetary conditions are indeed becoming easier. Of course the first thing we can conclude is that this shows that there is no “liquidity trap”. The central bank can always ease monetary policy – also when interest rates are zero or close to zero. The Bank of Japan is proving that at the moment.
Two things are happening at the moment in the Japan. One, the money base is increasing dramatically. Second and maybe more important money-velocity is picking up significantly.
Velocity is of course picking up because money demand in Japan is dropping as a consequence of households, companies and institutional investors expecting the value of the cash they are holding to decline as inflation is likely to pick up. The drop in the yen is a very good indicator of that.
And what do you do when you reduce the demand for money? Well, you spend it, you invest it. This is likely to be what will have happen in Japan in the coming months and quarters – private consumption growth will pick-up, business investments will go up, construction activity will accelerate.
…Hence, the Bank of Japan (and the rest of us) should celebrate the sharp drop in the yen as it is an indicator of a sharp increase in money-velocity and not because it is helping Japanese “competitiveness”.
Since then the Japanese economy has continued to recover (much more strongly than any other of the major developed economies in the world) and it has to a very large extent been about domestic demand rather than exports.
And this morning we got the latest confirmation of a recovery driven by domestic demand. Just take a look at this story from the Dow Jones News Wire:
Japan’s domestic sales of new cars, trucks and buses climbed 18.7% from a year earlier in December for the fourth straight month, rising from a low basis of comparison a year earlier when demand was hurt after the end of the government incentives to buy fuel-efficient cars.
Sales totaled 254,464 vehicles in December, up from 214,429 in the same month last year, the Japan Automobile Dealers Association said Monday.
Toyota sales rose 11.8% to 102,566, with its Lexus luxury brand registering a 15.1% increase to 3,414. Nissan sold 31,420 vehicles, up a modest 1.0%. Honda’s sales doubled to 38,767 from 18,886 after the introduction of the redesigned Fit compact in September.
With the latest monthly figures counted, the nation’s domestic auto sales for the calendar year 2013 fell 3.8% to 3.26 million vehicles from 3.39 million in 2012, the association said.
Auto sales, as measured by vehicle registrations with the government, are monitored by economists since they are the first consumer spending numbers released each month.
So let me say it again – it’s domestic demand, stupid!