All posts in category Bank of Japan

The Trump-Yellen policy mix is the perfect excuse for Trump’s protectionism

It is hard to find any good economic arguments for protectionism. Economists have known this at least since Adam Smith wrote the Wealth of Nations in 1776. That, however, has not stopped president-elect Donald Trump putting forward his protectionist agenda.

At the core of Trump’s protectionist thinking is the idea that trade is essentially a zero sum game. Contrary to conventional economic thinking, which sees trade as mutual beneficial Trump talks about trade in terms of winners and losers. This means that Trump essentially has a Mercantilist ideology, where the wealth of a nation can be measured on how much the country exports relative to its imports.

Therefore, we should expect the Trump administration to pay particularly attention to the US trade deficit and if the trade deficit grows Trump is likely to blame countries like Mexico and China for that.

The Yellen-Trump policy mix will cause the trade deficit to balloon

The paradox is that Trump’s own policies – particularly the announced major tax cuts and large government infrastructure investments – combined with the Federal Reserve’s likely response to the fiscal expansion (higher interest rates) in itself is likely to cause the US trade deficit to balloon.

Hence, a fiscal expansion will cause domestic demand to pick up, which in turn will increase imports. Furthermore, we have already seen the dollar rally on the back of the election Donald Trump as markets are pricing in more aggressive interest rate hikes from the Federal Reserve to curb the “Trumpflationary” pressures.

The strengthening of the dollar will further erode US competitiveness and further add to the worsening the US trade balance.

Add to that, that the strengthen of the dollar and the fears of US protectionist policies already have caused most Emerging Markets currencies – including the Chinese renminbi and the Mexican peso – to weaken against the US dollar.

The perfect excuse

Donald Trump has already said he wants the US Treasury Department to brand China a currency manipulator because he believes that China is keeping the renminbi artificial weak against the dollar to gain an “unfair” trade advantage against the US.

And soon he will have the “evidence” – the US trade deficit is ballooning, Chinese exports to the US are picking up steam and the renminbi continues to weaken. However, any economist would of course know that, that is not a result of China’s currency policies, but rather a direct consequence of Trumponomics more specifically the planed fiscal expansion, but Trump is unlikely to listen to that.

There is a clear echo from the 1980s here. Reagan’s tax cuts and the increase in military spending also caused a ‘double deficit’ – a larger budget deficit and a ballooning trade deficit and even though Reagan was certainly not a protectionist in the same way as Trump is he nonetheless bowed to domestic political pressures and to the pressures American exporters and during his time in offices and numerous import quotas and tariffs were implemented mainly to curb US imports from Japan. Unfortunately, it looks like Trump is very eager to copies these failed policies.

Finally, it should be noted that in 1985 we got the so-called Plaza Accord, which essentially forced the Japanese to allow the yen to strengthen dramatically (and the dollar to weaken). The Plaza Accord undoubtedly was a contributing factor to Japan’s deflationary crisis, which essentially have lasted to this day. One can only fear that a new Plaza Accord, which will strengthen the renminbi and cause the Chinese economy to fall into crisis is Trump’s wet dream.

 

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1 Comment
by Lars Christensen on November 18, 2016  •  Permalink
Posted in Bank of Japan, China, Donald Trump, Double deficit, Federal Reserve, Janet Yellen, Japan, Mexico, Plaza Accord, Protectionism, Renminbi, Trumpflation, Uncategorized
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Posted by Lars Christensen on November 18, 2016

https://marketmonetarist.com/2016/11/18/the-trump-yellen-policy-mix-is-the-perfect-excuse-for-trumps-protectionism/

In a deflationary world at the ZLB we need ‘competitive devaluations’

Sunday we got some bad news, which many wrongly will see as good news – this is from Reuters:

China and the United States on Sunday committed anew to refrain from competitive currency devaluations, and China said it would continue an orderly transition to a market-oriented exchange rate for the yuan CNY=CFXS.

…Both countries said they would “refrain from competitive devaluations and not target exchange rates for competitive purposes”, the fact sheet said.

Meanwhile, China would “continue an orderly transition to a market-determined exchange rate, enhancing two-way flexibility. China stresses that there is no basis for a sustained depreciation of the RMB (yuan). Both sides recognize the importance of clear policy communication.”

There is really nothing to celebrate here. The fact is that in a world where the largest and most important central banks in the world – including the Federal Reserve – continue to undershoot their inflation targets and where deflation remains a real threat any attempt – including using the exchange rate channel – to increase inflation expectations should be welcomed.

This of course is particularly important in a world where the ‘natural interest rate’ likely is quite close to zero and where policy rates are stuck very close to the Zero Lower Bound (ZLB). In such a world the exchange rate can be a highly useful instrument to curb deflationary pressures – as forcefully argued by for example Lars E. O. Svensson and Bennett McCallum.

In fact by agreeing not to use the exchange rate as a channel for easing monetary conditions the two most important ‘monetary superpowers’ in the world are sending a signal to the world that they are in fact not fully committed to fight deflationary pressures. That certainly is bad news – particularly because especially the Fed seems bewildered about conducting monetary policy in the present environment.

Furthermore, I am concerned that the Japanese government is in on this deal – at least indirectly – and that is why the Bank of Japan over the last couple of quarters seems to have allowed the yen to get significantly stronger, which effective has undermined BoJ chief Kuroda’s effort to hit BoJ’s 2% inflation target.

A couple of months ago we also got a very strong signal from ECB chief Mario Draghi that “competitive devaluations” should be avoided. Therefore there seems to be a broad consensus among the ‘Global Monetary Superpowers’ that currency fluctuation should be limited and that the exchange rate channel should not be used to fight devaluation pressures.

This in my view is extremely ill-advised and in this regard it should be noted that monetary easing if it leads to a weakening of the currency is not a beggar-thy-neighbour policy as it often wrongly is argued (see my arguments about this here).

Rather it could be a very effective way of increase inflationary expectations and that is exactly what we need now in a situation where central banks are struggling to figure out how to conduct monetary policy when interest rates are close the ZLB.

See some of my earlier posts on ‘currency war’/’competitive devaluations’ here:

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’

 

2 Comments
by Lars Christensen on September 4, 2016  •  Permalink
Posted in Bank of Japan, Bennett McCallum, Currency war, ECB, Federal Reserve, Haruhiko Kuroda, Lars E. O. Svensson, Mario Draghi, PBoC, Uncategorized
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Posted by Lars Christensen on September 4, 2016

https://marketmonetarist.com/2016/09/04/in-a-deflationary-world-at-the-zlb-we-need-competitive-devaluations/

Mikio Kumada tells the right story about the Japanese GDP numbers

Earlier today we got numbers for Japanese GDP numbers for Q4 2014. Watch my friend Mikio Kumada comment on the numbers here.

I fully share Mikio’s optimistic reading of the numbers. Bank of Japan’s quantitative easing is working and is lifting nominal spending growth.

Does that solve all Japan’s problems? No certainly not. It cannot do anything about Japan’s structural problems – particularly the negative demographics – but it is pulling Japan out of the deflationary-trap. And that is exactly what BoJ governor Kuroda set out to do. Now Prime Minister Abe has to deliver on structural reform, but that can be said about every industrialized country in the world.

PS Yes, I am positive about the Bank of Japan’s policy actions, but I still think it would have been much better with a NGDP level target for Japan rather than a 2% inflation target.

3 Comments
by Lars Christensen on February 16, 2015  •  Permalink
Posted in Bank of Japan, Haruhiko Kuroda, Japan, Mikio Kumada
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Posted by Lars Christensen on February 16, 2015

https://marketmonetarist.com/2015/02/16/mikio-kumada-tells-the-right-story-about-the-japanese-gdp-numbers/

Kuroda’s new team member – Yutaka Harada

If monetary policy is credible and strictly rules based who is running the central bank has little importance. However, if the central bank has not established full credibility then who is running the show will actually be important. Therefore, last week’s news that Yutaka Harada has been nominated for Bank of Japan’s board should certainly be noticed.

I personally have little knowledge of Professor Harada, but I of course have noticed that he has been both described as a “reflationist” and a “monetarist”.

Furthermore, it is notable that he is said to favour fiscal consolidation and structural reforms for Japan. This of course is as Scott Sumner notices the unique market monetarist “policy cocktail” that would be the right one for Japan in the present situation.

Harada’s monetarist insights

As I previously had not even heard of Harada I have done a bit of research on his views. Doing that I came across a paper – “Using Monetary Policy to End Stagnation” – he authored back in 2010. I am not sure Harada would describe himself as a monetarist, but his 2010 paper is certainly quite monetarist. Here is a few quotes…

First on the BOJ’s “restrictive policy”:

Compared with a growth strategy with indeterminate effects, stabilizing the value of the yen would produce quick results. Why has the yen become strong? The reason is a restrictive monetary policy. How can we say that policy has been tightened when interest rates remain so low? To answer this, we need to look at not interest rates but the money supply to see how much money is being fed into the economy.

Japan’s bias toward restrictive monetary control was excessive even in the wake of the global financial crisis…

…The BOJ argues that other countries needed to expand the monetary base in order to absorb the shock to their financial systems from the emergence of vast quantities of bad debts, and that Japan had no such need because domestic banks were not burdened by a heavy load of nonperforming loans. It is true that bad debts did not hobble Japan’s banks. Nonetheless, the global recession dealt a sharp shock to external demand, and the rising yen delivered a follow-up blow.

So we got a Hetzelian/Sumnerian explanation for the weak Japanese recovery after the “Lehman shock” in 2008 – the Japanese recovery in 2009-10 was weak because monetary policy was tight. The markets – the yen – is telling us that and low rates is not a sign a sign that monetary policy is easy.

So the crisis is one of weak demand, but Harada is skeptical that fiscal policy can be used to solve the problem:

Using fiscal policy to generate demand means stepping up government spending, which has to be paid for by either issuing government bonds or hiking taxes. Both of these funding methods involve collecting money from the public. Basically the government just takes money out of citizens’ right pockets and puts it back in their left pockets. Monetary policy works in a different way. A central bank is capable of expanding the money supply without limit. It can, for instance, buy government bonds and supply the market with funds. These are not funds it collects from the public, and so it can put money in citizens’ left pockets without taking anything from their right pockets.”

So Harada welcomes quantitative easing, but it needs to be done within a rule-based framework:

“Of course, adopting such a policy over an extended period of time would invite criticism, since it would trigger inflation and could wind up causing the kind of hyperinflation Zimbabwe has been suffering from. A policy of significantly expanding the money supply must therefore be left in place only for a while, after which the central bank must redirect its aim at a modest inflation rate of, say, 2%. This would be a policy of inflation targeting, and it provides one way of terminating more aggressive monetary relaxation.

Harada goes on to take on the traditional deflationist views of the BoJ (you could easily replace BoJ with ECB):

Although Japan’s prewar elite had some outstanding members, notably Takahashi Korekiyo, these days everyone seems to have swallowed the nonsensical line of the BOJ. Monetary policy, the bank argues, is not involved in the ongoing deflation. It points instead to such factors as inexpensive imports from China and other low-wage countries, price markdowns due to streamlining in distribution and deregulation, a sustained wage decline, and a lowering of growth expectations. Deflation is structural factor, the BOJ says, and no amount of money supply expansion would bring it to a stop.

We need to note, however, that whereas China is exporting low-priced goods around the world, it is only in Japan that prices are falling. Distribution streamlining and deregulation may well cause prices to drop, but they should also be expected to speed up the economy’s growth rate, and that has not occurred. Wages are indeed in the midst of a downward trend, but that is because of the ongoing deflation and business slump, which have been caused by the BOJ’s passive policy stance. Companies are hardly likely to hike wages at a time of falling prices and slim profits. An expectation of slower growth in the future is a certainly a cause of diminished demand, since many people will tighten their purse strings, but that does not automatically make it a deflationary factor. Slower growth would also cause future supply to diminish, and that would be an inflationary factor. Supply and demand factors are both involved in price movements, and we would need to know which is larger before calling lowered expectations a deflationary force.

And finally echoing Milton Friedman Harada explains the relationship between the stance of monetary policy and the level of interest rates:

“Here we should note that interest rates are low today not because the BOJ has adopted a policy of easy money but because it is sticking to a policy that is fostering deflation. If the BOJ had acted in the same way the Bank of Korea did when it expanded the monetary base to deal with the global financial crisis, probably the yen would not have appreciated, exports would not have dropped so far, and employment would not have been cut back so sharply. Japanese production would have recovered in tandem with the recovery of the world economy, and prices would not have fallen. With output expanding, profits would have improved, and both real and nominal GDP would have increased. All this would have set the stage for expectations of an upturn, and short- and long-term interest rates would have risen.”

We will see how Yutaka Harada actually performs on the BoJ’s board, but I think it is fair to say that the BoJ will take a step further in a monetarist direction with the nomination of Yutaka Harada to the BoJ board.

3 Comments
by Lars Christensen on February 9, 2015  •  Permalink
Posted in Bank of Japan, Haruhiko Kuroda, Yutaka Harada
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Posted by Lars Christensen on February 9, 2015

https://marketmonetarist.com/2015/02/09/kurodas-new-team-member-yutaka-harada/

The ECB should give Bob Hetzel a call

The ECB is very eager to stress that the monetary transmission mechanism in some way is broken and that the policy measures needed is not quantitative easing, but measures to repair the monetary transmission mechanism.

In regard to ECB’s position I find this quote from a excellent paper – What Is a Central Bank? – by Bob Hetzel very interesting:

For example, in Japan, the argument is common that the bad debts of banks have broken the monetary transmission mechanism. The central bank can acquire assets to increase the reserves of commercial banks, but the weak capital position of banks limits their willingness to engage in additional lending. As in the real bills world, the marketplace controls the ability of the central bank to create independent changes in money that change prices.

According to the quantity theory as opposed to the real bills view, a central bank exercises its control over the public’s nominal expenditure through money (monetary base) creation. That control does not derive from the central bank’s influence over financial intermediation. A commercial bank acquires assets by making its liabilities attractive to individuals who forego consumption to hold them. In contrast, a central bank acquires assets through the ability to impose a tax (seigniorage) that comes from money creation. It imposes the tax directly on holders of cash and indirectly on holders of bank deposits to the extent that banks hold reserves against deposits.

Bob wrote the paper while he was a visiting scholar at the Bank of Japan in 2003.

It is striking how the present position of the ECB is similar to the BoJ’s position at the time Bob spend time there. Maybe the ECB should invite Bob to pay a visit?

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See also Bob’s paper Japanese Monetary Policy and Deflation.

3 Comments
by Lars Christensen on June 9, 2014  •  Permalink
Posted in Bank of Japan, ECB, Real Bills doctrine, Robert Hetzel
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Posted by Lars Christensen on June 9, 2014

https://marketmonetarist.com/2014/06/09/the-ecb-should-give-bob-hetzel-a-call/

Let me say it again – The Kuroda recovery will be about domestic demand and not about exports

This morning we got strong GDP numbers from Japan for Q1. The numbers show that it is primarily domestic demand – private consumption and investment – rather than exports, which drive growth.

This is from Bloomberg:

Japan’s economy grew at the fastest pace since 2011 in the first quarter as companies stepped up investment and consumers splurged before the first sales-tax rise in 17 years last month.

Gross domestic product grew an annualized 5.9 percent from the previous quarter, the Cabinet Office said today in Tokyo, more than a 4.2 percent median forecast in a Bloomberg News survey of 32 economists. Consumer spending rose at the fastest pace since the quarter before the 1997 tax increase, while capital spending jumped the most since 2011.

…Consumer spending rose 2.1 percent from the previous quarter, the highest since a 2.2 percent increase in the first three months of 1997.

So it is domestic demand, while net exports are actually a drag on the economy (also from Bloomberg):

Exports rose 6 percent from the previous quarter and imports climbed 6.3 percent.

The yen’s slide since Abe came to power in December 2012 has inflated the value of imported energy as the nation’s nuclear reactors remain shuttered after the Fukushima disaster in March 2011.

The numbers fits very well with the story I told about the excepted “Kuroda recovery” (it is not Abenomics but monetary policy…) a year ago.

This is what I wrote in my blog post “The Kuroda recovery will be about domestic demand and not about exports” nearly exactly a year ago (May 10 2013):

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.

…I think that the way we should think about the weaker yen is as an 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.

…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.

While I am happy to acknowledge that today’s numbers likely are influenced by a number of special factors – such as increased private consumption ahead of planned sales tax hikes and likely also some distortions of the investment numbers I think it is clear that I overall have been right that what we have seen in the Japanese economy over the past year is indeed a moderate recovery led by domestic demand .

The biggest worry: Inflation targeting and a negative supply shock

That said, I am also worried about the momentum of the recovery and I am particularly concerned about the unfortunate combination of the Bank of Japan’s focus on inflation targeting – rather than nominal GDP targeting – than a negative supply shock.

This is particularly the situation where we are both going to see a sales tax hike – which will increase headline inflation – and we are seeing a significant negative supply shock due to higher energy prices. Furthermore note that the Abe administration’s misguided push to increase wage growth – to a pace faster than productivity growth – effectively also is a negative supply shock to the extent the policy is “working”.

While the BoJ has said it will ignore such effects on headline inflation it is likely to nonetheless at least confuse the picture of the Japanese economy and might make some investors speculate that the BoJ might cut short monetary easing.

This might explain three factors that have been worrying me. First, of all while broad money supply in Japan clearly has accelerated we have not see a pick-up in money-velocity. Second, the Japanese stock market has generally been underperforming this year. Third, we are not really seeing the hoped pick-up in medium-term inflation expectations.

All this indicate that the BoJ are facing some credibility problems – consumers and investors seem to fear that the BoJ might end monetary easing prematurely.

To me there is only one way to fundamentally solve these credibility problems – the BoJ should introduce a NGDP level target of lets say 3-4%. That would significantly reduce the fear among investors and consumers that the BoJ might scale back monetary easing in response to tax hikes and negative supply shocks, while at the same time maintain price stability over the longer run (around 2% inflation over the medium-term assuming that potential real GDP growth is 1-2%).

PS Q1 2014 nominal GDP grew 3.1% y/y against the prior reading of 2.2% y/y.

PPS See also my previous post where I among other things discuss the problems of inflation targeting and supply shocks.

1 Comment
by Lars Christensen on May 15, 2014  •  Permalink
Posted in Abenomics, Bank of Japan, Haruhiko Kuroda, Inflation Targeting, Japan, NGDP Targeting, Supply shock
Tagged , , , , ,

Posted by Lars Christensen on May 15, 2014

https://marketmonetarist.com/2014/05/15/let-me-say-it-again-the-kuroda-recovery-will-be-about-domestic-demand-and-not-about-exports/

The Kuroda boom remains all about domestic demand

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!

1 Comment
by Lars Christensen on January 6, 2014  •  Permalink
Posted in Bank of Japan, Haruhiko Kuroda, Uncategorized
Tagged , ,

Posted by Lars Christensen on January 6, 2014

https://marketmonetarist.com/2014/01/06/the-kuroda-boom-remains-all-about-domestic-demand/

Kuroda’s masterful forward guidance

This is from cnbc.com:

Talk of further monetary stimulus from the Bank of Japan helped push the yen to a six-month low and lifted the Nikkei to a six-month high on Tuesday, and the move in Japanese assets may have further to run, analysts say.

Comments made by Bank of Japan (BOJ) governor Haruhiko Kuroda on Monday fueled speculation of further easing, after he told participants at a conference “we are ready to adjust monetary policy without hesitation if risks materialize.”

Is forward guidance important? Yes, it is tremendously important – particularly is you have little credibility about your monetary policy target. The Bank of Japan for 15 years failed to meet any monetary policy target, but since Haruhiko Kuroda became BoJ governor things have changed. His masterful forward guidance has significantly increased monetary policy credibility in Japan.

Few in the market place today can doubt that governor Kuroda is committed to meeting his 2% inflation target and that he will do whatever it takes to hit that target. Furthermore, when Kuroda says that he is “ready to adjust monetary policy without hesitation if risks materialize” he is effectively making the the Sumner Critique official policy.

Said in another way – governor Kuroda will adjust his asset purchases – if necessary – to offset any other shocks to aggregate demand (or rather money-velocity) for example in response to the planned increase in Japanese sales taxes.

As a consequence of Kuroda’s forward guidance market participants know that the BoJ will offset any effect on aggregate demand of the higher sales tax and as a consequence the expected (net) impact of the sales tax increase is zero. This of course is the Sumner Critique – an inflation targeting (or NGDP targeting) central bank will offset fiscal shocks to ensure that the fiscal multiplier is zero.

So what is happening is that market participants expect monetary easing in reaction to fiscal tightening – this is now lifting Japanese equity prices and weakening the yen. This will boost private consumption, investment and exports and thereby offset the impact on aggregate demand from the increase in sales taxes.

The Bank of Japan likely have to step up its monthly asset purchases to offset the impact of the higher sales taxes as the BoJ’s inflation target is still not fully credible. However, given Mr. Kuroda’s skillful forward guidance the BoJ will have to do a lot less in terms of an actually increase in asset purchases than otherwise would have been the case. That in my view demonstrates the importance of forward guidance.

My expectation certainly is that the plan sales tax increase in Japan will once again demonstrate that the fiscal multiplier is zero under credible inflation targeting (also that the Zero Lower Bound!) and there is in my view good reason to think that the Japanese economy will continue to recover in 2014 – to a large extent thanks to governor Kuroda’s skillful forward guidance and his commitment to hitting the BoJ’s inflation target.

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Related post: There is no ’fiscal cliff’ in Japan – a simple AS-AD analysis

2 Comments
by Lars Christensen on December 3, 2013  •  Permalink
Posted in Bank of Japan, Fiscal cliff, Fiscal policy, Forward guidance, Haruhiko Kuroda
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Posted by Lars Christensen on December 3, 2013

https://marketmonetarist.com/2013/12/03/kurodas-masterful-forward-guidance/

“Whatever it takes to get deflation” (Stealing two graphs from Marcus Nunes)

Marcus Nunes has two extremely illustratative graphs in his latest blog post. Just take a look here:

 

 I don’t think any other comments are needed…

2 Comments
by Lars Christensen on November 29, 2013  •  Permalink
Posted in Bank of Japan, ECB, euro crisis, Marcus Nunes, The euro
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Posted by Lars Christensen on November 29, 2013

https://marketmonetarist.com/2013/11/29/whatever-it-takes-to-get-deflation-stealing-two-graphs-from-marcus-nunes/

End the euro crisis now with a 10% M3 target

This is Michael Steen in the Financial Times:

Inflation in the eurozone dropped unexpectedly to an annual rate of 0.7 per cent in October, far below the European Central Bank’s target of close to but below 2 per cent, and significantly increasing the chances of an interest-rate cut.

The so-called “flash” estimate by Eurostat, the EU’s statistical office, showed that the rate at which prices rise had slowed further since September, when it was 1.1 per cent, which is roughly what economists had expected for October.

A sharp outright fall in energy costs, by 1.7 per cent, drove the slowdown in the harmonised indices of consumer prices, which the ECB targets, but “core inflation”, which strips out energy, food, alcohol and tobacco, also fell to 0.8 per cent from 1 per cent.

I must say I am not the least surprised by the fact that the euro zone is heading for deflation. This is what I told The Telegraph’s Ambrose Evans-Pritchard back in March:

“Europe is heading into a deflationary scenario if they don’t do anything to boost the money supply,” said Lars Christensen… “This already looks very similar to what happened in Japan in 1996 and 1997.”

It is tragic, but what we are seeing now in Europe is exactly the same as we saw in Japan in the mid-1990s – a central bank that pursued extremely tight monetary policies, while it continued to maintain that monetary policy was indeed very easing. We all know the result of the Bank of Japan’s failed policies was 15 years of stagnation and deflation – and sharply rising public debt levels. The ECB unfortunately is copying exactly the policies of the (old) BoJ instead of learning the lesson from the new BoJ’s effective anti-deflationary policies.

As I have earlier argued the development in velocity and money supply growth in Europe today is very similar to what we saw in Japan around 1996-97. Not surprisingly the outcome is the same – extremely weak nominal GDP growth and deflationary tendencies. In fact the outcome is much worse. Unemployment in the euro zone just keep on rising – contrary to the situation in the US, where the Fed’s monetary easing over the past year has helped improve the labour market situation.

In fact the latest unemployment numbers for the euro zone published yesterday (Thursday) shows that unemployment in the euro zone has reached a record-high level of 12.2% in September and even worse youth unemployment is now 24.1%. It is hard not to conclude that the ECB is directly responsible for the millions of European being without a job. Yes, there are serious structural problems in Europe, but the sharp increase in unemployment levels in the euro zone since particularly since the ECB’s misguided rate hikes in 2011 is nearly totally the fault of the ECB’s extremely tight monetary policy stance.

We are heading for deflation

But lets get back to why deflation looks more and more likely in the euro. This is what I had to say about the matter back in March:

If you don’t already realise why I am talking about the risk of deflation then you just have to remember the equation of exchange – MV=PY.

We can rewrite the equation of exchange in growth rates and rearrange it. That gives us the the following model for medium-term inflation:

(1) m + v = p + y

<=>

(1)’ p = m + v – y

If we assume that money-velocity (v) drops by 2.5% y/y (the historical average) and trend real GDP growth is 2% (also more or less the historical average) and use 3% as the present rate of M3 growth then we get the follow ‘forecast’ for euro zone inflation:

(1)’ p = 3 % + -2.5% – 2% = -1.5%

So the message from the equation of exchange is clear – we are closer to 2% deflation than 2% inflation.

Yes, it is really that simple and the policy makers in the ECB should of course have realized this long ago.

End the euro crisis now with a 10% M3 target

There is only one way to avoid deflation in the euro zone and that is an aggressive monetary policy response in the form of a significant and permanent expansion of the euro zone money base within a clearly defined rule-based framework.

I would obviously prefer that the ECB implemented an clear NGDP level targeting rule, but less might do it – and a lot of other policy options would be preferable to the present mess.

The “easy” solution would be for the ECB to re-instate its former two-pillar monetary policy – a money supply (M3) growth target and an inflation target. Therefore, I suggest that the ECB imitiately issues the following statement (I have suggested it before):

“Effective today the ECB will start to undertake monetary operations to ensure that euro zone M3 growth will average 10% every year until the euro zone output gap has been closed. The ECB will allow inflation to temporarily overshoot the normal 2% inflation. The ECB has decided to undertake these measures as a failure to do so would seriously threatens price stability in the euro zone – given the present growth rate of M3 deflation is a substantial risk – and to ensure financial and economic stability in Europe. A failure to fight the deflationary risks would endanger the survival of the euro.

The ECB will from now on every month announce an operational target for the purchase of a GDP weighted basket of euro zone 2-year government bonds. The purpose of the operations will not be to support any single euro zone government, but to ensure a M3 growth rate that is comparable with long-term price stability. The present growth rate of M3 is deflationary and it is therefore of the highest importance that M3 growth is increased significantly until the deflationary risks have been substantially reduced.

The announced measures are completely within the ECB’s mandate and obligations to ensure price stability and financial stability in the euro zone as spelled out in the Maastricht Treaty.”

That would end the euro crisis, while also ensuring inflation around 2% in the medium-term. There would be no bailing out or odd credit policies. Only a clear and rule based policy to ensure nominal stability. How hard can it be?

12 Comments
by Lars Christensen on November 1, 2013  •  Permalink
Posted in Ambrose Evans-Pritchard, Bank of Japan, Deflation, ECB, Equation of exchange, euro crisis
Tagged , , , , , , ,

Posted by Lars Christensen on November 1, 2013

https://marketmonetarist.com/2013/11/01/end-the-euro-crisis-now-with-a-10-m3-target/

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