Sunday, August 24, 2014

Whither Japan's economy

Monetary policy as golf
Mainly due to a severe downturn in personal consumption stemming from the April 1 consumption tax increase from 5% to 8%, Japan's GDP in April-June tumbled a real 6.8% from the previous quarter on an annualized basis.

This is  more than many had forecast including the IMF. Although a slow down of Japan's economy was expected, there remains uncertainty as to its longterm consequences. Will Japan grow again? Answers focus on Abe's "third arrow" of structural reform.

During his recent vacation Prime Minister Abe met with a number of his economic advisers both formally and over golf. It appears that maybe he may be having doubts about Japan's economic recovery expected from the Bank of Japan's quantitative and qualitative monetary easing policy introduced in April 2013. He appeared, if not for mere political expediency, listening to a number of competing opinions on the way forward.

Jackson Hole, Wyoming
On August 23, at the Jackson Hole, Wyoming, Federal Reserve of Kansas annual economic symposium among central bankers Bank of Japan (BoJ) Governor Haruhiko Kuroda focused his remarks [includes charts] on raising wages and promoting labor participation by women and elderly people. Once the BoJ succeeds in "firmly anchoring inflation expectations at 2 pct, this could provide the basis" for wage negotiations between labor and management, he said. He emphasized that increased labor participation rate of women and elderly was critical for staving off serious labor shortage due to the aging of population. Utilizing foreign workers also "deserve consideration," he added.

In an August 15th post, Structural Reforms Can Help Japan's Post-Consumption Tax Blues, on the IMF's blog iMFdirect, Stephan Danninger, a division chief in the IMF's Asia and Pacific Department, underscored the need for Japan to promote structural reforms quickly after the country's gross domestic product in April-June suffered the worst contraction in 13 quarters: "With the near-term outlook looking increasingly uncertain, the government needs to move quickly on the third arrow of structural reforms." 

This paper was a was a follow up analysis IMF's annual staff report (Article IV Consultation) on Japan issued July 31st. The IMF believes Japan’s economy will grow by about 1.6 percent this year, before slowing to 1.1 percent in 2015 as a result of fiscal adjustment. Inflation is expected to rise temporarily to 2.8 percent on average for 2014 due to recent increase in consumption tax rate, and we expect the Bank of Japan’s 2 percent target will be achieved over the medium term. The report urged Japan to steadily implement its economic growth strategy and promote fiscal consolidation.

Uninterrupted structural and fiscal reforms are "vital" to the success of Abenomics, the IMF said. Noting that "further consolidation is needed to contain large fiscal risks," the IMF urged Japan to move ahead with an additional consumption tax rate increase to 10 pct planned for October 2015 after the 3-percentage-point hike to 8 pct in April this year.

Based on the staff report, the IMF Executive Board pointed out in a statement that "significant downside risks (to the Japanese economy) remain in the medium term, including those arising from fiscal vulnerabilities." The IMF board stressed "The best way to minimize these risks is the
steadfast implementation of all the elements of the government's economic strategy,"

There appears to have been a conference accompanying the preparation of the  Consultation. Here are some of the papers presented.

Japan’s Corporate Income Tax: Facts, Issues and ReformOptions. Author/Editor: Ruud A. de Mooij; Ikuo Saito, IMF Working Paper No. 14/138.
     Explores how corporate income tax reform can help Japan increase investment and boost potential growth. Using international and Japan-specific empirical estimates of corporate tax elasticities, investment is predicted to expand by around 0.4 percent for each point of rate reduction. International consensus estimates suggest further that between 10 and 30 percent of the static revenue loss could be recovered in the long run through dynamic scoring, although Japan’s offset may be closer to the lower bound. Compensating fiscal measures are necessary in light of Japan’s tight fiscal constraints. The scope for base broadening in the corporate income tax is found to be limited and some forms of base broadening will undo positive investment effects of a rate cut. Alternative revenue sources include higher consumption and property taxes. A gradual approach toward lowering tax rates mitigates windfall gains and reduces short-run revenue costs. An incremental allowance-for-corporate-equity system could boost investment with limited fiscal costs in the short run.

Is Japan’s Population Aging Deflationary? Author/Editor: Derek Anderson ; Dennis P. J. Botman; IMF Working Paper No. 14/139.
     Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need. Many of these factors will beset other advanced countries as well, but we find that deflation risk from aging is not inevitable as ambitious structural reforms and an aggressive monetary policy reaction can provide the offset.

Balance Sheet Repair and Corporate Investment in Japan. Author/Editor: Joong Shik Kang; IMF Working Paper No. 14/141.
     Traces Japanese firms’ behavior over the last decades using aggregate corporate balance sheet data. Financial health of Japanese corporate sector has improved and firms paid back significant amount of debt and rebuilt their liquidity buffers. They also expanded abroad while the pace of corporate investment moderated. Regarding the latter, model estimates on aggregate corporate investment over the post bubble period show that expectation about future profitability, in particular medium-term demand outlook, has been the major driver, implying that a successful implementation of structural reforms could have positive impact even in the near term by improving the medium-term demand outlook.

Health Spending in Japan: Macro-Fiscal Implications and Reform Options.  Author/Editor: Masahiro Nozaki ; Kenichiro Kashiwase ; Ikuo Saito. IMF Working Paper No. 14/142.
     Health spending has risen rapidly in Japan. We find two-thirds of the spending increase over 1990–2011 resulted from ageing, and the rest from excess cost growth. The spending level will rise further: ageing alone will raise it by 3½ percentage points of GDP over 2010–30, and excess cost growth at the rate observed over 1990–2011 will lead to an additional increase of 2–3 percentage points of GDP. This will require a sizable increase in government transfers. Japan can introduce micro- and macro-reforms to contain health spending, and financing options should be designed to enhance equity.

Future of Asia’s Finance: How Can it Meet Challenges of Demographic Change and Infrastructure Needs? Author/Editor: Ding Ding ; Raphael W. Lam ; Shanaka J. Peiris; IMF Working Paper No. 14/126
     There is a role for Asia’s financial sector to play to address the challenges associated with the region’s changing demographics and infrastructure investment needs. Enhancing financial innovation and integration in the region could facilitate intra-regional financial flows and mobilize resources from the aging savers in industrialized Asia to finance infrastructure investment in emerging Asia. Strengthening the financial ties within the region as well as with the global financial markets alongside appropriate prudential frameworks could also help diversify sources of financing and reduce the cost of funding in emerging Asia. Finally, financial deepening could help ease the potential overheating from scaling up infrastructure investment and hence achieve a more balanced growth in the region. 

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