The Kuroda recovery will be about domestic demand and not about exports

There has been a lot of focus on the fact that USD/JPY has now broken above 100 and that the slide in the yen is going to have a positive impact on Japanese exports. In fact it seems like most commentators and economists think that the easing of monetary policy we have seen in Japan is about the exchange rate and the impact on Japanese “competitiveness”. I think this focus is completely wrong.

While I strongly believe that the policies being undertaken by the Bank of Japan at the moment is likely to significantly boost Japanese nominal GDP growth – and likely also real GDP 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 is 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.

The weaker yen is an indicator of monetary easing – but not the main driver of growth

I think that the way we should think about the weaker yen is as a indicator for monetary easing. Hence, when we seeing the yen weakeN, Japanese stock markets rallying and inflation expectations rise at the same time then it is pretty safe to assume that monetary conditions are indeed becoming easier. Of course the first 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 expect 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. So it is no wonder that equity analysts feel more optimistic about Japanese companies’ earnings.

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”.

The focus on competitiveness is completely misplaced

I have in numerous earlier posts argued that when a country is going through a “devaluation” as a consequence of monetary easing the important thing is not competitiveness, but the impact on domestic demand.

I have for example earlier demonstrated that Swedish growth outpaced Danish growth in 2009-10 not because the Swedish krona depreciated strongly against the Danish krone (which is pegged to the euro), but because the Swedish Riksbank was able to ease monetary policy, while the Danish central bank effectively tightened monetary conditions due to the Danish fixed exchange rate policy. As a consequence domestic demand did much better in Sweden in 2009-10 than in Denmark, while – surprise, surprise – Swedish and Danish exports more or less grew at the same pace in 2009-10 (See graphs below).

Similarly I have earlier shown that when Argentina gave up its currency board regime in 2002 the major boost to growth did not primarly come from exports, but rather from domestic demand. Let me repeat a quote from Mark Weisbrot’s and Luis Sandoval’s 2007-paper on “Argentina’s economic recovery”:

“However, relatively little of Argentina’s growth over the last five years (2002-2007) is a result of exports or of the favorable prices of Argentina’s exports on world markets. This must be emphasized because the contrary is widely believed, and this mistaken assumption has often been used to dismiss the success or importance of the recovery, or to cast it as an unsustainable “commodity export boom…

During this period (The first six months following the devaluation in 2002) exports grew at a 6.7 percent annual rate and accounted for 71.3 percent of GDP growth. Imports dropped by more than 28 percent and therefore accounted for 167.8 percent of GDP growth during this period. Thus net exports (exports minus imports) accounted for 239.1 percent of GDP growth during the first six months of the recovery. This was countered mainly by declining consumption, with private consumption falling at a 5.0 percent annual rate.

But exports did not play a major role in the rest of the recovery after the first six months. The next phase of the recovery, from the third quarter of 2002 to the second quarter of 2004, was driven by private consumption and investment, with investment growing at a 41.1 percent annual rate during this period. Growth during the third phase of the recovery – the three years ending with the second half of this year – was also driven mainly by private consumption and investment… However, in this phase exports did contribute more than in the previous period, accounting for about 16.2 percent of growth; although imports grew faster, resulting in a negative contribution for net exports. Over the entire recovery through the first half of this year, exports accounted for about 13.6 percent of economic growth, and net exports (exports minus imports) contributed a negative 10.9 percent.

The economy reached its pre-recession level of real GDP in the first quarter of 2005. As of the second quarter this year, GDP was 20.8 percent higher than this previous peak. Since the beginning of the recovery, real (inflation-adjusted) GDP has grown by 50.9 percent, averaging 8.2 percent annually. All this is worth noting partly because Argentina’s rapid expansion is still sometimes dismissed as little more than a rebound from a deep recession.

…the fastest growing sectors of the economy were construction, which increased by 162.7 percent during the recovery; transport, storage and communications (73.4 percent); manufacturing (64.4 percent); and wholesale and retail trade and repair services (62.7 percent).

The impact of this rapid and sustained growth can be seen in the labor market and in household poverty rates… Unemployment fell from 21.5 percent in the first half of 2002 to 9.6 percent for the first half of 2007. The employment-to-population ratio rose from 32.8 percent to 43.4 percent during the same period. And the household poverty rate fell from 41.4 percent in the first half of 2002 to 16.3 percent in the first half of 2007. These are very large changes in unemployment, employment, and poverty rates.”

And if we want to go further back in history we can look at what happened in the US after FDR gave up the gold standard in 1933. Here the story was the same – it was domestic demand and not net exports which was the driver of the sharp recovery in growth during 1933.

These examples in my view clearly shows that the focus on the “competitiveness channel” is completely misplaced and the ongoing pick-up in Japanese growth is likely to be mostly about domestic demand rather than about exports.

Finally if anybody still worry about “currency war” they might want to rethink how they see the impact of monetary easing. When the Bank of Japan is easing monetary policy it is likely to have a much bigger positive impact on domestic demand than on Japanese exports. In fact I would not be surprised if the Japanese trade balance will worsen as a consequence of Kuroda’s heroic efforts to get Japan out of the deflationary trap.

HT Jonathan Cast


PS Scott Sumner also comments on Japan.

PPS An important non-competitiveness impact of the weaker yen is that it is telling consumers and investors that inflation is likely to increase. Again the important thing is the signal about monetary policy, which is rather more important than the impact on competitiveness.

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  1. Jonathon Hazell

     /  May 11, 2013

    Hi Lars,

    Great post. In fact the whole of the Great Depression substantiates this very point. The correlations that authors find (e.g. Eichengreen and Sachs) between date of leaving the gold standard and export growth over the 1930s generally don’t hold under scrutiny, but regression on output growth or consumption, and time of leaving the Gold Standard, mostly have done. It’s always interesting to see the extent to which the Great Depression is a Market Monetarist story, not just in the US but internationally. Have you thought about writing a post on Peter Temin’s work on regime change in the Great Depression as a Market Monetarist idea? The whole concept is about credible expected nominal income growth being the key exit from the Great Depression seems to be a great link to Japan today, and general MM ideas.

  2. Ravi

     /  May 11, 2013

    Terrific post. Forgive me if I’m getting some concepts crossed here, but how does this square with the idea of an “export price norm”? Should competitiveness or export considerations be the driving force for some economies? The debate around the value of the Aussie right now is quite interesting – I’m sure you have a view.

    • Ravi,

      Very good question. I should really write a post on “the transmission under a Export Price Norm”, however, let me try to comment a bit here

      The point with EPN is that a commodity exporting country control aggregate demand (NGDP) by pegging the currency to the price of the commodity the country exports. However, the assumption under EPN is also that the country’s export more or less equals all the country produces. However, pegging the currency to the export price is not about competitiveness, but about controlling aggregate demand.

      Hence, with EPN the exchange rate is the INSTRUMENT of monetary policy, while in the case of Japan the instrument is the money base and the exchange rates is primarily an INDICATOR of the monetary policy stance.

      There are no conflict between the two. In fact could easily have imagined a situation where the Bank of Japan had announced a target for the yen to achieve its inflation target. This is of course a variation of Irving Fisher’s Compensated Dollar Plan or what Lars E. O. Svensson terms the foolproof way out of deflation. See here:

      …as I am writing the this I realise I actually should have put it into the text that what I am arguing will happen in Japan and what Svensson was suggesting. I will try to return to that…

  3. jpirving

     /  May 11, 2013

    The Swedish/Danish export graph says so much. Swings in FX rates would seem to have little effect on the local currency value of exports from advanced economies. .

  4. Great post Lars, the stimulation of domestic demand is a very counter-intuitive result to a lot of people.

    Hopefully Bernanke and company are paying attention to what’s happening in Japan. I’m starting to think de facto NGDPLT is a real possibility within the next five years, hopefully followed by de jure.

  5. The Swedish/Danish example ignores two essential points:

    1) Denmark had highly overvalued real estate prices, Sweden did not, they had their real estate crisis in the 1990s. Danes reduced their debt in a balance sheet recession already from summer/autumn 2008 when the real estate market collapsed.

    2) For an open economy like Sweden or Denmark an increase in exports helps to reduce unemployment. Spending follows jobs.

    These two effects are a bit overlaid. In order to make your ideas more plausible you started in 2007. I suppose if you started in 2003, everybody would see that the big increase in Danish spending between 2003 and 2007/2008 and that if fell down to mean again.

    • George,

      You are right that private consumption grew fast in Denmark from 2003 until 2007/8 than in Sweden. However, there things to note about that:

      1) From 1998 to 2003 Danish private consumption was basically flat while Swedish private consumption grew fairly fast.

      2) If start the graph in 2003 – then we will see that fast the initial sharp drop in private consumption in 2008 Danish private consumption drops to the exact same level as in Sweden (10% up from 2003).

      3) HOWEVER, the point is that AFTER 2008 there has been no growth in private consumption in Denmark despite the fact that the “overshoot” compared to Sweden disappeared already in 2008-9. Swedish private consumption is now 8% HIGHER than in Denmark if we start out with 2003 at index 100 for both countries.

      So yes, Danish private consumption might have overshot and so might property prices. A orderly correction of this started in 2006, but when the monetary shock hit in 2008 the Danish economy went into deep crisis. We have not seen any growth in private consumption since 2008. This has NOTHING to do with a “balance sheet recession”. It is simply a result of ECB overly tight monetary policies.

  6. Ben Southwood

     /  May 12, 2013

    I wrote something similar about the UK, responding to a Civitas pamphlet: (any comment appreciated)

  7. Have you considered the risk that an energy shock could hit the domestic economy, and perversely, trigger a new round of deflation as the consumer spending you envision is cramped hard by food and energy costs?

  8. marksadowski

     /  May 13, 2013

    George Dorgan,
    Doesn’t the same website (Bubble Bubble) have a post on the Swedish Housing Bubble?

    Also, this source confirms that house prices went up by almost exactly the same amount (100%) in both Sweden and Denmark between 1999 and 2007:

    Click to access ifcb31j.pdf

    The main difference is that in Sweden housing prices didn’t plummit in 2008 and 2009.The fall in Danish housing prices is obviously related to the excessively tight monetary policy needed to defend the peg to the euro during that time period.

  9. Mads Llindstrøm

     /  May 14, 2013

    I am new to market monetarism (not even an economist), but I did find the Scott Sumner podcast about market monetarism at Econtalk extremely convincing, see

    However, I was wondering, if your explanation of Denmark/Sweden 2008-12 is accurate, what would one expect should have happened to inflation. Well, if Sweden had a stronger demand than Denmark, one would expect higher inflation. Also, Swedish loose monetary policy (relative to Denmark), would also lead to inflation.

    So what happened?

    Danish and Swedish inflation ( and

    CPI Denmark CPI Sweden
    2012 1.98 % -0.05 %
    2011 2.51 % 2.29 %
    2010 2.84 % 2.34 %
    2009 1.44 % 0.58 %
    2008 2.43 % 0.90 %
    2007 2.31 % 3.45 %
    2006 1.80 % 1.64 %
    2005 2.21 % 0.88 %

    Except for 2007, the Swedish inflation has been lower than the Danish inflation, which leads me to believe that there might be a hole in the market monetarist storyline. What am I missing?

    A different explanation for Denmark/Sweden 2007-2012 could be that it is a lot more expensive to lay off people in Sweden than in Denmark. Therefore Swedish employers will keep a higher employment than necessary in times of crisis. This leads to both increased production (more labour) and to higher consumption, as less people has been fired and are thus willing to consume more. The increased production makes the raise in consumption without inflation credible. The excess employees should also lead to lower Swedish corporate profits. I did however not find any numbers on aggregate corporate profits by year in Sweden and Denmark, so that is left as an exercise for the reader.

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