Japan: Shifting Targets, to Growth

Published on February 27, 2015

The early successes of Bank of Japan Governor Haruhiko Kuroda’s bold monetary policy in lifting Japan out of deflation and towards his stated target of 2% inflation have clearly stalled.

The impact of the massive expansion of Japan’s monetary base and central bank balance sheet has run into the headwinds of falling energy prices, negative real wage growth as pay raises continue to lag asset and non-commodity goods inflation, and the continued drag on demand of a sales tax hike, despite Prime Minister Shinzo Abe’s decision last December to hold off on the second installment of those hikes (see SGH 11/11/14, “Japan: Sales Tax Delay and Early Elections“).

*** Even as Kuroda continues to counsel patience, maintaining as recently as yesterday in testimony to the Japanese Diet that the big picture trend in inflation expectations remains on track, his fuzzy time-line for hitting the 2% target in fiscal year 2015 has been drifting back, and will soon have to be formally revised. ***

*** In this, Kuroda has been just given a political assist from the influential Special Advisor to the Cabinet, Professor Koichi Hamada, who has suggested it may be more appropriate for the BOJ to revise its emphasis from targeting Core CPI, which excludes Fresh Food, stripped of the effects of the sales tax hike, to “Core-Core CPI,” which also excludes the effects of energy prices. ***

*** But it is not just the closely followed monetary policy target that is coming up for revision, but Japan’s long term fiscal target as well. Although the Abe Cabinet has not officially given up its target of achieving a zero deficit in FY 2020, our understanding is that officials in the Ministry of Finance and Cabinet believe that is no longer possible, and will embark on a strategy of damage control focused on presenting a list of measures to shrink the budget deficit beyond 2020. ***

*** We suspect the Abe Cabinet may even de-emphasize the goal of a zero deficit by FY 2020 in favor of some targeting of the ratio of the outstanding national debt over nominal GDP. And that ratio can be brought down through a substantial boost in the size of nominal GDP either through economic growth (in real terms), or inflation, without slashing spending as aggressively as would be required under a 2020 zero deficit target. ***

Focus on Multipliers and Growth

On February 12, Japan’s Cabinet Office submitted the results of its long term simulation of the Japanese Budget. According to that simulation, the primary budget in FY 2020 will not be balanced, but rather show a deficit of 9.4 trillion yen, assuming a 3% nominal GDP growth rate.

There has been considerable pushback on those forecasts however from senior political leaders, from Economy Minister Akira Amari and Chief Cabinet Secretary Yoshihide Suga among them, and from what we understand even Abe himself, for being too conservative in estimating future tax income.

In a nod to supply side economics, they maintain the 3% assumptions being used for the elasticity of tax revenues to economic growth have been too low, and should rather be closer to 4%. For Japan, it is historically true that in the initial stages of a recovery that elasticity has usually reached around 4% in the short run.

But according to the officials involved in the preparations of those forecasts, that rate has tended to slow to around 1% once the economy enters a period of steady growth.

Regardless, this internal debate demonstrates the emphasis that is being put by the Abe Cabinet on the impact of economic growth on increases in tax revenues, and it implies a renewed push for further fiscal stimulus as opposed to more aggressive tax hikes or additional cuts in spending.

An End to Consumption Tax Hikes

When it comes to the consumption tax, Abe has already pledged to follow through in April 2017 on the postponed second leg of hikes from 8% to 10%. But there will be little time left after that to hike it above 10% before 2020, if it is to happen at all, given the overwhelmingly negative public opinion now against higher consumption tax rates.

And the Democratic Party of Japan and other opposition parties have been making hay out of the unpopular consumption tax hike, attacking Abe for expanding the wealth gap among the Japanese, citing the popular Thomas Piketty book on income inequality still making the rounds in Japan.

But all that is mostly political noise on the margin, as for their part most LDP politicians are in no mood anyway for any tax increases beyond those already pledged.

And they have no problem instead in focusing on additional stimulus, and for generous support to their constituencies and related industry groups.

To wit, it is widely believed in Tokyo political circles that the relationship between Kuroda and Abe took a major hit after Abe postponed the second installment of the consumption tax hike, despite Kuroda having delivered a second dollop of QQE in October.

Kuroda, of course, has been a major proponent of these tax hikes. On February 12, at the Council on Economic and Fiscal Policy, he is said to have firmly asserted that any erosion in the credibility of Japan’s budget could create the risk of JGB yields spiking. But in the minutes of the Council released on February 17, these points in Kuroda’s remarks were all but deleted.

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