Aggressive Monetary Policy Bad For Japan?

http://blogs.ft.com/money-supply/2012/03/25/shirakawa-four-problems-with-aggressive-monetary-policy/#axzz29z4kJ8wF

This article is a bit outdated, but given the previous post’s argument that deflation has been a long term concern of Japan, I think that its arguments are still valid. It makes 4 counter-arguments against the premise that an aggressive monetary policy may be the solution to heavy deflation:

1. An expansionary monetary policy might allow people to pay their debts easier, but it disincentivizes both the private and public sector from balancing budgets. Shirikawa also argues that those without debts are incentivized to spend more, bring future demand to the present and increasing aggregate demand. This increase will diminish over time despite low interest.

2. The prolonged nature of shocks in China’s government might prompt companies to further invest in low interest investments that would only be profitable with aggressive monetary policy. This is an inefficient allocation of resources.

3. Flattening the yield too far will also cause inefficient allocation of resources and undermine profitability. Long term investments could yield negative returns.

4. Mr. Shirakawa’s fourth point is an argument about why banks such as fed should worry about the effect of easy policy of global commodity prices. In essence, he says that individual central banks that concentrate on domestic inflation targets that could end up causing global problems, which in turn make it hard to hit domestic inflationary targets.

The last point is rewritten from the site. It is what really confused me, and I think it’s really important. I would appreciate some input on explaining it to me.

From what I know of economics, an expansionary monetary policy to combat inflation seems textbook, but most of these counterpoints seem valid in this specific scenario.

4 thoughts on “Aggressive Monetary Policy Bad For Japan?”

  2. the prof

    All of these are long-standing criticisms of monetary policy, and not just in Japan. However, it makes a lot of difference whether you are in a deep recession and/or deflation. So …

    1. The cost of public debt (any debt) is a function of real interest rates, adjusted for growth. [If you’re a firm with revenue growing by 10% for the next few years, debt’s less of an issue than if you have declining revenue. Ditto for a growing vs a stagnant economy. As we’ll discuss later this term, the relevant variable at the aggregate level is the nominal interest rate less the nominal GDP growth rate.]
    i. However, if no one else wants to borrow – 0% interest rates are a good sign of that – there are no side effects to government borrowing, and if the money is used to create jobs, it may be a pretty good investment from a societal perspective.
    2. Low interest rates may or may not have much impact on consumer spending and on corporate investment.
    i. The only direct channel is through consumer loans and in particular mortgagers – and it’s less important in Japan because banks require bigger downpayments, so people don’t tend to buy houses until they’re in the 40s or 50s.
    ii. Indirectly it lowers the return on savings, which may require that you save more to supplement retirement, not less. That’s the income effect, with higher interest rates you earn less on your savings and so have reduced potential income over time. The article only notes the substitution effect, that you may want to pull consumption forward or shift it into the future in response to the change in opportunity cost represented by the change in interest rates.
    iii. Business investment is dominated by expectations. Most investment is financed out of cash flow, so interest rates only matter in an opportunity cost sense. Furthermore, businesses typically use a payback period (5 years or 3 years) or internal rate of return threshold (15%-20%) that is far higher than interest rates. A 1 pct point rise in rates thus would shift the required internal rate of return from (say) 18% to 19%. Not many projects would be cancelled on that basis.
    3. If there were lots of high-paying investments staring firms in the face, then the economy would be growing more rapidly and interest rates would rise. But firms are being conservative. In part that’s because if producer prices are falling at 3% pa, then with a bank rate of around 1.5% pa, businesses face a real interest rate of 4.5%. In a low-GDP-growth environment, that’s not necessarily so cheap. [Note that this is a “levels” argument whereas that above was a “change in levels” argument. Also, firms can’t borrow at the “call rate”, the overnight interest rate equivalent to the Fed Funds rate in the US, which is the only rate the Bank of Japan can directly influence].
    4. I have no idea what is meant by “flatten the yield will hurt corporate profitability.” If managers want to invest in dud projects, well, yes, but investment doesn’t suggest that Japanese businessmen are rushing to build things in the manner they did during the late 1980s bubble.
    5. Finally, commodity prices do respond to the opportunity cost of holding them. Whenever rates are really low, we find high wheat and corn and gold and even oil prices. People sit on inventories, rather than selling them. Does that lead to inflation? In the developed world, neither food nor energy are large enough shares of consumption to feed into a generalized inflation, and in particular wage increases. Wages are the biggest cost overall in the OECD countries, Japan included. So if higher food prices don’t get workers rioting for higher wages [OK, workers haven’t rioted in Japan since 1960], then they don’t lead to inflation. Reflecting that, the Bureau of Labor Statistics in the US and the Prime Minister’s Office in Japan report “core inflation” without including food and commodities, which are very volatile on a monthly basis and empirically simply don’t correlate with overall inflation. This is not true for developing countries. In China, food prices matter much more, because people are poorer and spend more of their budgets on food. So the government is much more sensitive to the price of meat and rice.
  3. frontline

    European integration in JHA, after Maastricht treaty was able to go so fast, mainly because of previous experiences of European Coal and Steel Community and European Community. Member states in 90’s knew how to built a cooperation, and knew also shouldn’t be done in order not to slow down or stop the integration process.

  4. wilburns

    This could be totally unrelated, but would Suzuki’s recent exit from the US auto market be a symptom of Japan’s situation regarding this issue? The article outlining the exit mentioned that the strong yen–a lack of inflation– was a central cause for poor sales in the US. It did not mention any upcoming high-paying investments for Suzuki, but their poor sales over the past few years and an expectation that Toyota’s Prius and other hybrid vehicles would continue to do well could have played into their decision.

    http://www.guardian.co.uk/business/2012/nov/06/suzuki-pulls-out-us-car-market
    http://www.businessweek.com/news/2012-11-05/toyota-raises-profit-forecast-after-sales-in-u-dot-s-dot-japan-gain

    The method of exit used by Suzuki to get out of the US was Chapter 11. Now, that could have just been the simplest way to exit, but it could be a genuine necessity for Suzuki if their debt was substantial. Furthermore, Suzuki’s sales have been on the decline since 2007. They could be the “firm [with]…declining revenue” the Professor mentioned. In that case, Suzuki’s US debts could have been a serious problem posing a threat to their more successful operations in India and elsewhere.

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