Stimulus in Japan

Monday 07/25/16

     Shinzo Abe's Liberal Democratic Party secured a two-thirds majority in Japan's upper-house of parliament earlier this month. Abe, Japan's Prime Minister now has even more support to continue his economic agenda known as Abenomics. Abenomics has been successful in weakening the yen, but the economic benefits were short lived and in recent months the yen has strengthened. The Bank of Japan is meeting this week to discuss possible stimulus measures and at the same time Abe's government is putting the finishing touches on a major stimulus package. In this post we'll look at what to expect from both a fiscal and a monetary policy aspect.

Monetary Policy

     Haruhiko Kuroda, the head of the Bank of Japan (BOJ), has been very creative with respect to monetary policy to put it mildly. The BOJ has pursued an aggressive policy of quantitative easing and now owns over one-third of Japan's bonds. However, the BOJ's asset purchases have not been limited to just bonds, they are also buying ETFs and REITs. In addition to unprecedented quantitative easing, Kuroda has also lowered interest rates into negative territory.

     Somewhat counterintuitively, the decision to move to negative interest rates actually strengthened the yen, the opposite effect of what Kuroda intended. I suspect that the reason the yen strengthened following that decision was the way it was unveiled. Kuroda lied to parliament just before he left to the World Economic Forum in Davos, by telling them that he was not considering negative rates. Upon returning from Davos, the BOJ adopted negative interest rates. The vote passed the BOJ board by a vote of 5-4, this is significant because it shows that Kuroda may no longer have the votes he needs to adopt further monetary easing. Kuroda was strongly opposed by three board members, strongly backed by three members and was able to convince two swing votes who had been on the fence. Now that the yen has strengthened, the opposite of the intended effect, Kuroda may no longer have control of the board.

     Another interesting story is the involvement of former U.S. Federal Reserve Chair Ben Bernanke who recently met with the Abe, the bank of Japan and key officials. Esturo Honda, one of Abe's top economic advisers stated that, “During an hour-long discussion with Bernanke the Former Federal Reserve chief warned there was a risk Japan at any moment could return to deflation. He noted that helicopter money in which the government issues non-marketable perpetual bonds with no maturity date and the Bank of Japan directly buys them could work as the strongest tool to overcome deflation.” Since this plan has the backing of Ben Bernanke, who is well-respected, it would be less likely that they would upset U.S. officials who might accuse them of currency manipulation.

Fiscal Policy

     Going forward we are likely to see more from Japan in terms of fiscal policy. Unlike Kuroda, Abe has expanded his electoral power and can now proceed with his agenda of fiscal stimulus. Reports have suggested a stimulus package of at least 20 Trillion yen (about $190 Billion USD). Much of that stimulus will be used for infrastructure spending which will do almost nothing to tackle the real structural problems facing Japan. Japan's structural problem is an aging population and a lot of government debt. I believe that the main goal of this stimulus is to create more bonds that can be bought by the BOJ because they are running out of bonds that can be monetized.

     The other question is what will happen to the proposed sales tax increase. Abe has already delayed the sales tax increase that was expected to take effect next year. This is already a major source of fiscal stimulus. If he cancels the increase altogether that would be likely have the effect of weakening the yen, but he may also lose credibility.

     There is no doubt that Japan is planning something big, but the market is also expecting something big. If Abe fails to deliver, the yen could strengthen in the short term and cause more pain for Japan's exporters. Japan is in a difficult situation and it doesn't seem as though there are any good solutions at this point.