The Third Arrow of Abenomics: How Far Will It Reach? Ito... · · 2015-09-29The Third Arrow of...

The Third Arrow of Abenomics: How Far Will It Reach?

Takatoshi Ito* University of Tokyo October 24, 2013

* In addition to teaching career at Minnesota, Harvard, Hitotsubashi and Tokyo, the author has been Senior Advisor at Research Department, IMF (1994-1997); Deputy Vice Minister, Ministry of Finance (1999-2001); and Member, Prime Minister’s Council on Economic and Fiscal Policy (2006-2008) under PM Abe and PM Fukuda. Currently, a chair of council of experts to reform GPIF.

Zadankai at CJEB, Columbia University

Takeaways • (0) Three arrows: Abenomics is a package of 3 arrows:

• (1) 1st Arrow: Aggressive Monetary Policy, Early success

– QQE by new BOJ Governor Kuroda, April 4 – Yen depreciation (by 25%) and Stock prices increases (by 50%)

• (2) 2nd Arrow: Flexible Fiscal Policy, now on track – Short-run success. 2013Q2 growth rate was high. – Consumption tax will rise to 8% in April 2014 as scheduled

• (3) 3rd Arrow: Growth Strategy, yet to be released – Most critical element. Many candidate areas: e.g., – Agriculture; health care; female labor force promo; energy

• All combined:

– A Jump from a bad (deflation) to a good (normal) equilibrium

October 24, 2013 (c) Takatoshi ITO 2

How three arrows are working • Three arrows: Abenomics is a package of

→ Arrow 1. Monetary policy: Inflation targeting & QQE → Arrow 2. Fiscal policy: Short-run stimulus → Arrow 3. Growth strategy: Structural reforms

• Arrow 1 Stock price up Wealth effect Consumption

• Arrow 2 Gov expenditure; but only 2013Q1 &Q2 – Good growth VAT rate increase, April 2014

Consumption intertemporal substitution 2014 Q1 UP; and Q2 Down

– Need VAT increase to avoid fiscal crisis • Arrow 3 Serious reform/deregulation this fall to

stimulate Investment 2014 Q2&Q3 October 24, 2013 (c) Takatoshi ITO 3

• Objective. To break “deflationary expectation” – The real interest rate (= nominal rate – πe) will decline, & – Investment and Consumption will be stimulated

• Is it credible? – Credible as the BOJ under Gov. Kuroda is committed to QE

• (Skeptic) Does QE work? – (Answer) It worked in FRB, BOE, ECB preventing deflation. – (Answer) Timing and communication is important

• BOJ, important developments – 2% Inflation targeting on January 22, 2013, under Gov. Shirakawa – April 4, 2013: Quantitative and Qualitative Easing (QQE) under Gov.

Kuroda – April 24, 2013: Outlook, forecast of 1.9% by 2015

• See also, Takatoshi Ito, “Abenomics: Early Success and Prospects” Spotlight, September/October 2013, pp. 4-7


Targeting Inflation

Early Success (mid-Nov, 2012 to end-April 2013)

• Yen depreciation and stock price rise, mid-Nov to April – The USD/JPY moved from 78 yen to 98 yen/$

• 20% depreciation – Stock prices (Nikkei 225): 8660 13,800

• 50% increases

• PM Abe’s approval rating has increased – Emphasis on the economy is working

• This is NEW, compared to Episode I (2006-07) – Strong leadership (e.g., inflation targeting); No wobbling – Politically controversial issues are shelved

• Patriotic education • Constitution reform: status for Self-Defense Force (SDF) • Also Chinese aggression is helping Abe’s popularity so far

(c) Takatoshi ITO 5 October 24, 2013


Yen/USD (2012/1/1/- 2013/10/10)


Nikkei 225(2012/1/1/- 2013/10/10)

• Quick fix: a short-run stimulus to raise the growth rate, 2013Q2 – To win the upper house election in July – Important data for a decision of “a go” or “a no-go” for consumption

tax increases will be decided in October 2013 – In concerted efforts with BOJ to raise π – Supplementary budget will be spent by end-June

• But controversial – Contents. Public works reminds of “Old style LDP (pre-Koizumi)” – But, that is an only way to disburse quickly

• (Skeptic) Could this hasten an eventual fiscal bust? – (A) Mostly maintenance and repair of infrastructure – But, yes, fiscal consolidation is needed in medium-term – In the medium term, growth policy will work to replace fiscal stimulus

• Important: Short-term stimulus and Medium-term consolidation


Stimulus Fiscal

Fiscal sustainability • Fiscal situation is very bad—unsustainable

– Debt-GDP ratio much worse than fiscal crisis counties in the Euro zone. Worst among OECD.

– In the general account budget, half of expenditures are financed by new bond issues

• Total budget 2013 is about • Tax revenues are less than half of total expenditure

• Correction – Raise tax rates: consumption; income; corporate – Cut expenditure Japan is lowest in Gov ex/GDP; social

security related expenditures are rising rapidly – Economic growth Even with very high growth rate, it

would not be enough • Best option is to raise consumption tax rate


Half of the budget is bond issues!


Pension Related Special Deficit-Financing bonds

National Debt Service

Primary Balance Expenditures

Tax Revenues

Government Bond Issue

Fiscal Policy: Defying Gravity Medium-term consolidation needed

• Takeo Hoshi and Takatoshi Ito, “Defying Gravity: How Long Will Japanese Government Bond Prices Remain High?” NBER wp. 18287, August 2012.

• Take-away – Japanese financial institutions buy most JGBs

• Domestic holding, more than 90% • They are extremely risk-averse

– Household saving is flat and will be declining – An increase in corporate saving goes into saving – A ceiling of stable JGB increases is the sum of Private Sector

(Household and Corporate) saving (mostly bank deposits) – Simulation exercises show that the ceiling will be hit by 2021 – A crisis will happen before that date


Controversy: consumption tax hike “As scheduled” vs. “Delay”

• Legislation (August 2012)—agreed by 3 major parties – April 2014: 5% 8%; October 2015: 8% 10%

• Objections – Prof. Hamada and Mr. Honda – special advisers to Cabinet—argued for delay

in tax hike – The “as scheduled” vs. “Delay” became a huge political issue in August 2013

• Interviews of 60 experts from August 26 to 31 – Group interviews, 7 groups – Interviewers: Ministers Aso and Amari; Governor Kuroda, and 4 private-sector

members of CEFP – More than 42 people supported “as scheduled”.

• See pros and cons in the following slides, and also – Takatoshi Ito, “Japan Must be brave—it is time to put up taxes,” Financial

Times, September 9, 2013 – Takatoshi Ito, “Consumption tax fears risk stalling Abe’s ‘three arrows’ East

Asian Forum, September 8, 2013


“Delay” “as scheduled” • Economy is fragile;

Economy may fall back to stagnation and deflation if tax hike


• Economy is firmly expanding – Q1: 3.8% &Q2: 4.1% – Expected to continue

positive growth – Even with tax hike, BOJ

expects CPI inflation rate will become close to 2% in 2015

Announcement Date 2012 Q2 2012 Q3 2012 Q4 2013 Q1 2013 Q2

2013/5/16 -0.9 -3.5 1 3.52013/6/10 -0.6 -3.6 1.2 4.12013/8/12 -0.9 -3.6 1 3.8 2.62013/9/9 -1.2 -3.5 1.1 4.1 3.8

“Delay” “as scheduled” • Lesson of 1997: tax

rate hike from 3% to 5% produced a negative growth in 1998


• Recession in 1998 was due to Asian financial crisis and Japanese banking crisis

• True lesson of 1997: has to address a major problem early, NPL in the 1990s and fiscal unsustainability in 2000s

“Delay” “as scheduled” • (silence)


• Amending the rate hike requires a new law – Takes time and political capital delay in the third arrow

– The market would react negatively; stock price decline

• Suspension leads foreign investors to believe that PM Abe is weak and Abenomics will fail; they unwind positions – Yen will appreciate – Stock prices will fall – 1st arrow will be broken

What are the forecasts (as of August 2013) telling us?

• Up and down (intertemporal substitution) in consumption will realize – A big “rush-to-buy” boom (4%, QtoQ, annualized

growth rate) in 2014:1st quarter. – A big decline (minus 5%, QtoQ annualized growth

rate) in 2014:2nd quarter • This up-and-down (mini business cycle) can be

smoothed by counter-cyclical government expenditures (15 month budget is desirable)

• A permanent decline due to a decline in purchasing power of consumers


GDP forecasts with and without consumption tax rate hike

October 24, 2013 (c) Takatoshi ITO 21 Author’s calculation

• In the medium- to long-run, the economy needs – Consumption and Investment increases – Productivity gains & Wage increases – Growth without fiscal stimulus

• But which industries? – Backward Industries due to lots of regulations are the

hopefuls • Health and medical care • Agriculture

– FTA and TPP – Capital Markets and the Public Pension fund reform

• See T. Ito, “Abe should aim his third arrow at Japan’s farmers” Financial Times, June 2013.


Strategy Growth

TPP (Trans-Pacific Partnership) • TPP is a big deal for Japan

– A chance to recover from a late start and implementation in FTAs with large trading partners.

– A chance to do domestic reform in the name of external liberalization (gai-atsu)

• Japan has mentioned 5 sensitive areas (“sacred areas”) : Rice, Wheat, Beef and Pork, Dairy Products, and Sugar

• But, PM Abe has been clever in not giving a clear language of protection October 24, 2013 (c) Takatoshi ITO 23

FTA/EPA in the past

• Japan has been lagging behind Korea and China, not to mention Australia and Singapore, in concluding FTAs

• Japan’s existing FTAs do not cover important trading partners – Not having FTAs are disadvantage for Japanese

exporters such as • “Agriculture” is the stumbling bloc in negotiating

FTAs with US, Australia and NZ •


Japan’s FTA


Comments: Important trading partners are missing: US, EU, and China Those concluded are countries with little threat of importing agricultural products The so-called “liberalization ratio” is below 90% for Japan

Source: Ministry of Foreign Affairs

What does Japan have to do in conclusion of TPP?

• Liberalization more than 96% … • Japan’s tariff lines: 9018 • Of which , 5 “Sacred Areas” have 586 (6.5% of all tariff

lines) – Rice: 58 – Wheat: 109 – Beef and pork: 100 – Dairy products: 188 – Sugar: 131

• Currently rumored to “protect” only 366 (4.1%) – Other 200 some items are mostly (semi-)processed products – Would that be enough to conclude TPP? – Would that be acceptable domestically?


Agricultural Coop has prevented productivity increases

• Agricultural coop, JA, has been a strong political lobby • JA’s instinct

– Maximize its membership • Against policies to push scale economies • Strong area should be sacrificed to help the weakest

– Cut production when demand decreases (due to population declines and taste changes)

• Not interested in exports – Keeping high tariffs protects Japanese farmers who are

disadvantaged by small arable land • Japanese agricultural economists are mostly Marxists


The dairy industry as an example

• Raw milk drinking milk Dairy products (cheese; butter; LL milk; etc)

• Should the industry be protected by high tariff?

• Not really – Raw milk imports are unthinkable – Dairy product imports may increase, but really? – Lots of room to increase domestic productivity


Should we protect the “dairy” industry?

• No. Agricultural Cooperatives and the Ministry (MAFF) argue – NZ low-price dairy products will kill the Japanese dairy

industry – The current tariffs, e.g., 38.5% for cheese should be

maintained (“sacred area”) • Yes. The gradually lowering tariffs will stimulate

structural reform and the Japanese dairy industry will become a strong industry. Specifically – Production quota – All or nothing rule of raw milk sales to Regional Coop


Regulation • Japan is divided into 10 districts • [Production quota] The ministry decides how much to produce and

put quota to Regional JA, and Regional JA to each JA, each JA to each farmer

• There is one regional JA that is a monopoly in distribution of raw milk. The regional JA buys raw milk from farms and sells them to milk and dairy products production companies.

• [ALL or Nothing for each farm] Each dairy farm has to choose either (a) sell all raw milk to the regional JA monopoly or (b) process all raw milk by itself for milk and dairy products

• The regional JA monopoly sells raw milk to dairy product companies • The price of raw milk for “milk” and that of raw milk for “other dairy

products” are different. For milk is higher.

• Basically, this is a socialist “planned economy” – No incentive to “innovate”


The number of dairy farms, trend

• Source: http://www.j-milk.jp/expertise/db/8d863s000006bcmw.html


http://www.j-milk.jp/expertise/db/8d863s000006bcmw.html

Average cost of raw milk (100kg)

Ex-Hokkaido

Hokkaido

National


Yen

Policy implications • Scale economies exist

– By accelerating mergers of farm, costs can be reduced – When large farms become dominant and “brand”

marketing becomes possible, domestic products become competitive

• Hokkaido milk farms are “exploited”—they should be liberated – Farms with lowest costs cannot expand production

(government control, via Shitei Dantai) – Farms with low cost cannot claim high sales prices,

because most raw milk is sold for processed products rather than drinking milk (government control, via Shitei Dantai)

– Domestic distortion should be corrected in parallel with import liberalization


Policies backed by growth theory • Measures have been discussed in Episode I (2006-07) • Labor. Policies to increase:

– Raise women participation, age 30-40 (need more nurseries) – More foreign workers (esp. health care workers) – Continue working 65+ workers (delay retirement)

• Capital. Prevent hollowing out – Lower corporate income tax – TPP and FTA (incentive to produce in Japan) – Capital market reform (encourage taking risk)

• Technological Progress – Innovation/deregulation in backward industries – Releasing potentials in agriculture, health care services – Rectify the problem in the energy sector

• Can nuclear power plants be restarted?


Conclusion • Abenomics is working fine, so far

– [1st arrow] Monetary policy is right on the target – [2nd arrow] Fiscal stimulus works in the short run – 2013Q1, growth rate (QtoQ) 0.9% (or annualized 3.5%)

• Abenomics, the success means a jump from a bad, deflationary equilibrium to a good, normal equilibrium

• Once in the good equilibrium, fiscal stimulus will not be needed

• [3rd arrow] Growth strategy will be a key to raise growth potential; to erase fiscal debt concern; to raise wages; and to complete the jump

• Risk is too much a distraction to political agenda


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