The future never resembles the past – as we well know. But, generally speaking, our imagination and our knowledge are too weak to tell us what particular changes to expect. We do not know what the future holds. Nevertheless, as living and moving beings, we are forced to act. – John Maynard Keynes
Discussions of the population problem have always had the capacity to stir up public sentiment much more than most other problems.
- Gunnar Myrdal
Last Thursday the yen broke through the psychological threshold of 100 to the US dollar. On Friday the slide continued (see chart), even dropping very close to 102 to the USD at one point before strengthening slightly on the run in to the G7 finance ministers meeting.
The ostensible source of the sudden shift was a news release from the Japanese Ministry of Finance detailing the fact that Japanese investors bought a net total of 514 billion yen ($5.2 billion) in foreign bonds during the two weeks to May 3. Speculation had been rife that Japanese money funds would start to respond to continuing yen weakness and low Japanese yields by investing abroad. It is still far from clear that this is really going to happen in the short term, but nonetheless the news was sufficient to spark bets on more yen weakness.
Naturally the fall has drawn comment, especially during the run up to last weekend’s G7 meeting. US Treasury Secretary Jack Lew told CNBC that while Japan had “growth issues” that needed to be dealt with its attempts to stimulate its economy needed to stay within the bounds of international agreements to avoid competitive devaluations.”I’m just going to refer back to the ground rules and the fact that we’ve made clear that we’ll keep an eye on that,” he said in a comment that was widely seen as drawing a red line in the sand.
But really, what else do external observers expect? On 4 April Bank of Japan governor Haruhiko Kuroda announced he was going to increase the money base by 1% of GDP per month for the next two years. That is to say Japan’s monetary expansion will be incremental and continuous. Kuroda has even stated he will continue to increase the money base beyond the initial 24 months if the targeted inflation doesn’t come. It was always clear that the country was going to have a difficult time trying to generate inflation and that one of the knock-on consequences would be to continually weaken the yen. So you can’t realistically expect him to turn round and say now, “sorry, we didn’t know it would offend you so, I’m cancelling the policy”. Anyway, that move would throw financial markets straight into turmoil. Didn’t they understand what they were signing up to when they accepted “Abenomics” at the last meeting?
Obviously there is still a considerable amount of confusion around about what exactly Japan’s problem is, and what the policy is trying to achieve. I have tried to examine the more theoretical background to the problem in my A-b-e of economics post, but looking through the comments to that piece I realised that I was very tightly focused on one, examining only one aspect of what has come to be known as Abenomics, the inflation targeting component and its theoretical justification. Since ideas about what exactly it is the Japanese government is trying to achieve seem to be many and various, I thought it might be worth coming back and taking a second look at the experiment.
Three Arrows Into The Sunset
The aim of Abenomics is obviously to shake Japan out of its deflationary lethargy and return the country’s economy to a more pronounced growth path. In order to achieve this Japan’s Prime Minister has notoriously identified three policy arrows, or transmission mechanisms:
1) Aggressive monetary easing
2) Strong fiscal stimulus
3) An extensive programme of growth enhancing structural reforms
Achieving the inflation target is effectively the key objective of the first arrow, and weakening the yen is basically the transmission mechanism which achieves the objective. In fact while we have heard a good deal concerning the first two arrows, there is still relatively little on the table regarding the third one, as some commentators have started to wryly note.