Japan is different, right? Wrong! Fiscal policy works

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Japan is different, right? Japan has a different culture, right? Japan has sustained low unemployment, low inflation, low interest rates, high public deficits and high gross public debt for 25 years, but that is cultural, right? Even the mainstream media is starting to see through the Japan is different narrative as we will see. Yesterday (August 14, 2017), the Cabinet Office in Japan published the preliminary – Quarterly Estimates of GDP – which showed that the Japanese economy is growing strongly and has just posted the 9th quarter of positive annual real GDP growth. Private consumption and investment is strong, the public sector continues to underpin growth with fiscal deficits and real wages are growing. The Eurozone should send a delegation to Tokyo but then all they would learn is that a currency-issuing government that doesn’t fall into the austerity obsession promoted by many economists (including those in the European Commission) can oversee strong growth and low unemployment. Simple really. The Japan experience is interesting because it demonstrates how the reversal in fiscal policy can have significant negative and positive effects in a fairly short time span, whereas monetary policy is much less effective in influencing expenditure.

The UK Guardian article (August 15, 2017) – Japanese economy posts longest expansion in more than a decade – reported that:

Japan’s economy expanded at the fastest pace for more than two years in the three months to June, with domestic spending accelerating as the country prepares for the 2020 Toyko Olympics and low levels of unemployment encouraged businesses to invest …

The overall result was much stronger than expected by the market …

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I presume that will mean the UK Guardian will refrain henceforth from publishing articles from economists or their own journalists that suggest that fiscal policy is ineffective, Japan is about to go bankrupt, Japan is about to hyper-inflate, or any other stupid claim that has been rehearsed since the early 1990s by mainstream commentators and which the likes of the Guardian have given oxygen.

The following graph shows the growth of real GDP from the March-quarter 2007 to the June-quarter 2017. The annual growth (year-on-year) is in blue bars while the red line is the quarterly growth rate.

On an annual basis, Japan recorded an annual growth rate of 2.1 per cent in the June-quarter, the 9th quarter that annual growth has been positive.

The ‘sales tax’ recession of 2014 result, which was the direct outcome of neo-liberal incompetence is now well and truly behind it.

The quarterly growth rate was 1.0 per cent up from 0.4 in the March-quarter.

This is a very strong result and a testament to the on-going effectiveness of fiscal policy.

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It is worth reminding ourselves of the folly of 2014 in Japan, which replicated the fiscal policy mistakes made in 1997.

In April 2014, the Abe government raised the sales tax from 5 per cent to 8 per cent.

After the sales tax hike, there was a sharp drop in private consumption spending as a direct result of the policy shift. At the time, I predicted it would get worse unless they changed tack.

It certainly did get worse. Consumers stopped spending and the impact of static consumption expenditure was that business investment then lags.

Here is the history of real GDP growth (annualised) since the March-quarter 1994 to the March-quarter 2015. The red areas denote sales tax driven recessions.

In both episodes, these recessions were followed by a renewed bout of fiscal stimulus (monetary policy was ‘loose’ throughout). In both episodes, there was a rapid return to sustained growth as a result of the fiscal boost.

Nothing could be clearer.

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I provided detailed analysis of these historical shifts in these blogs:

1. Japan returns to 1997 – idiocy rules!.

2. Japan’s growth slows under tax hikes but the OECD want more.

3. Japan – signs of growth but grey clouds remain.

4. Japan thinks it is Greece but cannot remember 1997.

You might wonder what happened in 2002? The recession that occurred then in Japan was largely driven by an export collapse (remember the US went into recession during this period) and a tightening of net public spending. This then provoked a fall in private investment spending and a rising saving rate. It had nothing to do with the ratings decision.

Once exports recovered and public spending support resumed the economy then grew relatively strongly despite the lower sovereign debt ratings.

And then the 2007 crisis arrived.

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Consumption spending growing strongly

Private consumption spending grew at 0.9 per cent in the June-quarter 2017 and by 1.8 per cent in the previous twelve months.

The following graph shows growth in private consumption spending since the March-quarter 2007 to the June-quarter 2017. The blue bars are the annual (year-on-year) outcome, while the red line is the quarterly result.

This is one of those magnificent graphs that you show students to demonstrate intervention effects of government policy. Private consumption growth was growing fairly strongly on up to the beginning of 2014, after the impacts of the GFC and the Tsunami had been overcome.

The sales tax hike had the predictable negative effect and the quarterly growth of private consumption ever since was rather subdued until confidence returned.

In the last three quarters, that confidence appears to have returned and household consumption growth has been robust.

This has been helped by strong growth in wages.

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Investment spending growing strongly

With the stronger household consumption spending and the generally better economic outlook for Japan, private capital formation is now also contributing strongly to growth.

That is a message that is often forgotten. Fiscal stimulus boosts confidence, consumers start spending, sales increase, and firms a motivated to expand productive capacity – a virtuous cycle.

These boosts are in contrast to the mainstream macroeconomics, which consistently claims that the non-government sector will cut spending if the fiscal deficit rises. It is total nonsense, of course.

The following graph shows the annual growth in private investment from the March-quarter 2007 to the June-quarter 2017.

The outlook is bright.

Part of this boost in capital formation is due to the infrastructure being built in preparation for the 2020 Tokyo Olympics. But the overwhelming influence is the brighter sales environment as consumers spend more freely.

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Contributions to growth

The next graph shows the contributions (in percentage points) to real GDP growth of the major expenditure categories in Japan over the last quarter and over the last 12 months (to the June-quarter 2017).

The annual results capture the impact of the introduction of the sales tax (April 2014) and its aftermath.

The major categories of expenditure that you would expect to be affected, either directly (private consumption) or indirectly (private investment) were negatively impacted.

It is also clear that over the last year, all the expenditure categories (public and private consumption, public and private capital formation, net exports) have contributed strongly to growth.

While net exports subtracted from growth in the June-quarter 2017, it boosted growth by 0.43 percentage points over the 12 month period.

The contribution of private consumption and investment is notable as is the sustained boost to growth from the public sector.

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Consumer and Business Confidence

The Japanese Cabinet Office publishes a – Monthly survey of Consumer Confidence. The latest results, released on August 2, 2017 (for a survey conducted in July 2017) tells us:

1. “Consumer Confidence Index (seasonally adjusted series) in July 2017 was 43.8, up 0.5 points from the previous month.”.

2. All components that influence the Consumer Perception Indices were positive:

Overall livelihood: 42.3 (up 1.2 from the previous month)

Income growth: 41.7 (up 0.1 from the previous month)

Employment:48.1 (the same as the previous month)

Willingness to buy durable goods:43.2 (up 1.0 from the previous month)

The Cabinet Office also publishes Monthly – Indexes of Business Conditions.

The latest result (August 7, 2017) showed that conditions were “Improving” in June 2017. The following graph is their latest time series (since January 2014).

Things have been looking up since mid 2016.

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Real Wages growing steadily

The following graph shows the quarterly growth in real compensation for employees from the March-quarter 2007 to the June-quarter 2017.

With some exceptions, real purchasing power has been growing steadily since the sales tax disaster in 2014-15 was resolved with renewed fiscal expansion.
I note that recently more commentators are starting to appreciate that Japan demonstrates, categorically, that mainstream macroeconomic theory is bereft and has no credibility.

A recent Bloomberg article (August 3, 2017) – Japan Buries Our Most-Cherished Economic Ideas – concludes that:

Japan is the graveyard of economic theories. The country has had ultralow interest rates and run huge government deficits for decades, with no sign of the inflation that many economists assume would be the natural result.

The “theories” should, in fact, be singular – mainstream macroeconomic theory (particularly New Keynesian economics).

Modern Monetary Theory (MMT) has always been able to embrace the evidential base produced by Japan.

There is no surprise to an MMT economist that:

1. Japan has large fiscal deficits relative to other nations.

2. It has relatively large gross public debt.

3. Its bond yields have been low and stable for decades.

4. It has had close to zero interest rates for decades.

5. It has low inflation.

6. It has very low unemployment.

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It all comes down to understanding how the monetary system operates and the recognising capacities that a currency-issuing national government has to use fiscal and monetary to advance well-being.

The Bloomberg article notes that:

Some economists think more fiscal deficits could help raise inflation. That’s consistent with a theory called the “fiscal theory of the price level,” or FTPL. But a quick look at Japan’s recent history should make us skeptical of that theory — even as government debt has steadily climbed, inflation has stumbled along at close to 0 percent …

The mainstream theory doesn’t understand that fiscal deficits are no more likely to cause inflation as growth in non-government spending should the capacity of the economy be able to absorb the extra nominal spending.

If it is not capable, then there is no need to expand the deficit because the economy would already be at full employment!

But the Bloomberg journalist (Noah Smith) can see that Japan kills off mainstream economic theory, as an academic economist he still wants to hang on to it.

He claims that:

There’s just one catch — government debt.

With long-term interest rates very low and tax receipts rising due to economic growth, Japan’s mountain of government debt isn’t as bad as it appears. The government can roll over long-term bonds at increasingly low interest rates until interest payments essentially vanish. But as long as that mountain of debt remains, Japan will be forced to keep interest rates low. This situation is known as “fiscal dominance,” and it means the central bank no longer has effective control over its own monetary policy. That’s not catastrophic, but it’s not optimal. Inflation, if it ever materialized, could help erode that debt.

Which tells you that he hasn’t understood much at all.

And the terminology – “mountain of government debt” – is telling.

First, Japan’s central government debt to GDP ratio is in net terms – once you take into account the fact that the Japanese government holds huge stockpiles of financial assets – around 90 per cent.

Second, the Bank of Japan holds a significant amount of government bonds. If these are taken out the debt ratio drops to around 45 per cent

Hardly a mountain. But then who cares if the numbers were higher than this anyway? No-one should.

Japan can always meet its yen-denominated liabilities, irrespective of the interest rates. The only difference is that with low interest rates, the fiscal space is larger for non-interest payment spending.