Japanese Economy in the Recent Years
Introduction
During the advent of economic downturns particularly in terms of financial crises or bubbles, the usual resort of the government is to rely primarily on its monetary tools alongside expansionary fiscal policies to stimulate the economy.
Monetary policies are tools used to deal with inflation, budget deficits, unemployment, incomes, international economic relationships among others. Monetary policies have profound effects on our jobs, incomes, livelihood, and career choices.
One of the considerations and is always on the watch in an economy is the behavior of prices of the goods and services. As the law of demand states that with an increase in the price of a particular good/service, it corresponds to a potential decrease in the quantity demanded, ceteris paribus. Hence, the government’s objective is to stabilize the price of the commodities and if there is a rise in prices then it should be on the minimum level.
Inflation and Monetary Policy
Generally, inflation is defined as the rise on the overall level of prices. It is often considered as a negative economic phenomenon because a rise in the prices of commodities puts pressure on the purchasing power of the households’ disposable income. Further, it also affects the net present value of savings and discourages investments. In extreme cases, high inflation causes social unrest when not immediately resolved (Jahan, 2012).
The most common tool being used by central banks to regulate inflation rate is the existing market interest rates. This is due to the fact that inflation rate and interest rate tend to move in opposite directions. A central bank will either increase or decrease the existing interest rate depending on the behavior of inflation rate (Jahan, 2012).
All countries set a low single digit inflation targets. Zero is not recommended as an inflation rate value since it inhibits the real interest rates to fall sufficiently and thus stimulate aggregate demand. It hampers the objective of the central government to boost the economy.
In terms of the effect of inflation rate to monetary policy, the central bank forecasts the path of inflation in the next 5-10 years and compare it with the target inflation. The difference between the forecasted inflation rate and the targeted inflation rate serves as the basis on the adjustment that has to be done in the monetary policy.
Inflation targeting is advantageous since it is a combination of the “rules” and “discretion” in the monetary policy. These two elements include the precise numerical target for inflation in the medium term and a corresponding responding to potential economic shocks in the short-term (2 to 3-year horizon). With this in mind, central banks focus on inflation target on the medium term and not at all times. This framework gives the central bank the opportunity to address their other objectives such as smoothing output over the short run period.
Recent studies show that in emerging economies, inflation targeting is relatively more effective than other monetary policies in anchoring public inflation expectations. It also appeared that countries which anchored their monetary policy on inflation targeting are more effective in dealing with the recent financial crises (Jahan, 2012).
In the case of the more advanced economies such as U.S., Europe, Switzerland and Japan, their central banks have also adopted many of the main elements of inflation targeting. However, some of these economies do not explicitly announce their inflation rate target and/or they do not have other fiscal objectives such as promoting full employment status and moderate long-term interest rates.
Monetary Easing and the Economy of Japan
In 2013, the Bank of Japan (BOJ) has peg its inflation rate target at 2%. As a rule of thumb, BOJ stated that it will promote sustainable and stable prices by identifying a “price stability target”. This target is viewed to contribute towards the attainment of the sound development of the national economy (Bank of Japan (BOJ) website, 2013). Alongside the price stability target is restating the framework of the conduct of the monetary policy.
BOJ defined price stability as “a state where various economic agents including households and firms may make decision regarding such economic activities as consumption and investments without being concerned about the fluctuations in the general price level”. BOJ recognizes that a stable price in a sustainable basis will pave the way to strengthen the competitiveness and growth potential of Japan’s economy. Hence, the bank peg the “price stability target” at 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI).
On September 21, 2016, BOJ releases the revised framework on strengthening monetary easing as a tool to stimulate the Japan economy. The original Quantitative and qualitative Monetary Easing (QQE) and QQE with a Negative Interest Rate frameworks formulated in April 2013, were reinforced by QQE with Yield Curve Control aim to achieve the price stability target of 2 percent by the BOJ at the earliest possible time.
Under these monetary easing frameworks, BOJ will have the full control on short-term interest rates and expand the monetary base until the year-on-year rate on increase in the observed CPI exceeds the 2 percent price stability target in a sustainable manner.
The short-term interest rate policy includes BOJ applying a negative interest rate of minus 0.1 percent to the Policy-Rate Balances in the current accounts of financial institutions at the BOJ. In terms of the long-run interest rate, BOJ will be purchasing Japanese Government Bonds (JGBs) in order for the 10-year JGBs to remain at the current level (around zero percent).
Since the Japan economy is experiencing deflation for quite some time, the national government through the BOJ created monetary policies such as the price stability target at monetary easing to help boost the sluggish economy.
The recovery of Japan’s economy from the financial crisis of 2008 still remain in its moderate paced due to the decline in export and production in the recent years. The continuous decline in the growth of emerging economies greatly affected the export production of Japan. In terms of domestic demand, it has been observed that business fixed investment is on moderate increasing trend. The strong domestic demand causes a spill-over effect to the consumption spending and employment level. However, it is expected that the export production of Japan will remain sluggish for a while which will result to a slow pace in the economic recovery of the country.
On the other hand, financial conditions are quite promising. Although, it is expected that inflation expectations will be rising in a relatively longer-term perspective, they have already weakened. The rate of change on the year-on-year rate of change in the consumer price index (CPI) has been reported to be slightly negative.
BOJ stated some potential risks to the improvement of the Japan economy. These include the impact to the global financial markets and global economy of the decision of the United Kingdom’s vote to leave the European Union, the uncertainties in its surrounding emerging markets and commodity-exporting economies such as China among others (BOJ website, 2016).
Effectiveness of the Monetary Policy
Based from the assessment of BOJ, after more than three years since it introduced the QQE in 2013, it has resulted to significant improvement in the Japan economy. For one, the country is no longer in deflation, which is characterized by a sustained declined in process. Further, since the implementation of the QQE with negative interest rate framework, JGB yields, lending rates and interest on corporate bonds and CP have significantly decreased. This indicates that the monetary policies implemented have substantial effects to the economy. In terms of the real economy, unemployment rate decreases by around 3% while the output gap has improved to 0% (long-term average). CPI for all except fresh food and energy remains to be positive for almost three years now.
However, the general goal or objective of the Bank, which is to achieved the 2% price stability target has not been achieved. The failure of the Bank to meet the target was attributed to several economic setbacks that happened in the international market. Even with the expansions being done by BOJ, its immediate effects are hampered by following; (1) The decline in the price of crude oil since summer 2014 which resulted to weak aggregate demand; (2) the deceleration of global economic growth due to the slowdown of the emerging economies; (3) volatile developments in the financial markets.
Despite the negative interest rates imposed by BOJ and the continuous buy in of JGB, the economy of Japan is still fighting to attain sustainable and stable prices. Some economists express their opinion and warned the BOJ that their plan to further expand the negative interest rate being imposed and its modification in purchasing JGB will disturb the normal functioning of the economy and the financial system. The BOJ has already implemented monetary easing in unprecedented level since 2013 (Tachikawa, 2016).
The failure of the monetary easing policies of BOJ to stabilize market prices has also affected the perspective of investors. In an article written by Nakamichi and Fujikawa(2016) in the Wall Street Journal, investors are disappointed with the modest dose of stimulus being implemented by the BOJ. The investors are expecting bolder moves from the BOJ which could complement the new government spending plan to jumpstart the economy.
Conclusion
The current economic situation of Japan is compelling and very intricate. As a developed economy, it is highly influenced by the fluctuations in the international market. And in the current status of developed economies, Japan shares the same dilemmas as to US and Europe.
It is also worthy to note that Japan’s economy is highly dependent on its export production. With the downturn of the commodity-exporting economies, Japan will be directly affected. This complicates the problem since the inflow of money from the export production continuously decreases since 2014. There is a need to remedy the problem alongside the efforts of the BOJ to stabilize and reduce the inflation rate to 2%.
It is not to say that the monetary easing policy of the BOJ is not effective as evidenced by the assessment made by the Bank. However, it may not be enough to jolt the sluggish economy.
References:
Bank of Japan. (2013). “Price Stability Target” of 2 Percent. Retrieved from https://www.boj.or.jp/en/announcements/release_2013/k130122b.pdf on January 7, 2017.
Bank of Japan. (2016). New Framework for Strengthening Monetary Easing: "Quantitative and Qualitative Monetary Easing with Yield Curve Control". Retrieved from https://www.boj.or.jp/en/announcements/release_2016/k160921a.pdf on January 7, 2017.
Bank of Japan. (2016). Comprehensive Assessment: Developments in Economic Activity and Prices as well as Policy Effects since the Introduction of Quantitative and Qualitative Monetary Easing (QQE). Retrieved from https://www.boj.or.jp/en/announcements/release_2016/k160921b.pdf on January 7, 2017.
Jahan, S. (2012). Inflation Targeting: Holding the Line. International Monetary Fund. Retrieved from http://www.imf.org/external/pubs/ft/fandd/basics/target.htm on January 7, 2017.
Nakamichi, T. and Fujikawa M. (2016). Bank of Japan Takes Modest Easing Action. The Wall Street Journal. Retrieved from http://www.wsj.com/articles/bank-of-japan-takes-easing-action-1469764904 on January 7, 2017
Tachikawa, T. (2016). Economists Worry Over BOJ’s Next Step. The Japan Times. Retrieved from http://www.japantimes.co.jp/news/2016/09/16/business/economists-worry-bojs-next-step/#.WHC3vlUrI1g on January 7, 2017.
