The Impact of Japanese Fiscal Policy on Japans Government Debt - Example

Title: Managerial Economics Name: Course: Institution: Date: Table of Contents Table of Contents 0 Introduction 1 The difference between inflation and deflation 2 Circumstances for deflation to occur and how the government can deal with them 3 Convectional monetary policy 4 The challenge of convectional policy 4 The difference policy between convectional and Quantitative Easing 5 Quantitative easing (QE) 5 The impact of Japanese fiscal policy on Japan’s government debt 6 The predictions of standard economic theory and the actual level of interest rates in Japan 6 Causes and implication for the appreciation of the Japanese yen 7 ‘Abenomics’ and its prospect for successes 8 The relevance of economic problems and policies 9 Conclusion 10 References 12 Introduction The government of Japan through the bank of Japan has adopted different measures to curb the deflation that is facing it. They have fiscal and monetary which have proved not much effective and need to be re-evaluated. This report focuses on the economic problems and policies in Japan as well as the various ways of dealing deflation. It provides an analysis on the difference between the conventional monetary policy and quantitative easing. The difference between inflation and deflation The term Inflation is defined as the occurrence, whereby price of commodities is high while else the value of money is deteriorated over a length of time. Inflation is also defined as substantial increase in price. A number of economists have defined it as a situation where the value of commodities rises more than the value of money over specific period of time (Svensson 2002). On the other hand, deflation can be defined as the occurrence of disequilibrium which it is as a result of contraction of purchasing power, hence declining the price intensity. Similarly, deflation can be defined as the fall of commodity price as a result of an increase of commodity production in the market thus, increasing monetary income (Buiter 2003). The difference between inflation and deflation is that inflation is a phenomenon where the common price level has an optimism growth rate while else deflation is occurrence where the index of consumer’s money has a declining rate of growth. In summary, inflation is the increase of money value while deflation is decrease of commodity prices (Buiter 2003). Preference of moderate inflation to deflation First, with the use of the inflation concept, the Japanese Authority is able to pay-off the governments debts appropriately. This occurs when the rate of inflation increases enabling the GDP to grow at a higher rate than the deficit rate, hence reducing the debt ratio. Inflation concept in this occurrence increases the rates of bondholders who are paid- off with the inflated currency, thereby relieving the Japanese taxpayers from paying huge amounts of money (Svensson 2002). Economically, with Inflation, it does not reduce the community’s income as compared to deflation that reduces the income of the community thus, resulting to poverty. Secondly, inflation is an employment phenomenon since it increases the level of employment in the country as compared to deflation which is an under employment concept, thus accelerates the rate of unemployment in the economy. It is easy to control inflation by the use of fiscal policy. On the contrary, deflation is not easy to control. The reason being, in cases of deflation, there is a high chance of negativity in business environment. This is caused by decline of marginal efficiency which diminishes business capital, lowers the growth rate of business causing depression in the economy (Svensson 2002). However, in this occurrence of deflation, monetary policy is not applicable and increase of money in an attempt to raise the price level is impossible. As compared to an inflated economy, money and credit supply can be controlled. Therefore, mild inflation could stimulate the growth of Japanese government. Moreover many economists have acknowledged that with inflation, there can be an economic productivity, though warns that if inflation is not controlled well, there can be a huge negative impact on the country’s economy (Svensson 2002). Circumstances for deflation to occur and how the government can deal with them Deflation occurrence can be caused by increase in supply while the price level remains low. It is as a result of inequality of the sum total of expenditure in comparison to the output value of prices. This is expressed by the value of money rising up while the prices fall down. Another circumstance causing inflation is the fall of demand of goods that causes building up of prices and deflation in banks. In addition, deflation may be caused by combination of both the bank’s inflation and cash building up. In cases of deflation, the government or central bank lowers the nominal maturity rate used in monetary policy. When interest rates (nominal) and private sector (expectations) is lowered, it decreases the short (real) interest rate. In conditions where the nominal interest rate is low, which means both the inflation and expected inflation is low; the central bank does not lower the interest rates further. Fiscal and monetary policy is example of alternatives used to settle deflation in the economy. This is applied when the central bank purchases the debts of the government. Eventually, increasing prices, decreasing outstanding government’s liability and stimulates goods output, allowing for gradual tax cut off (Svensson 2002). Convectional monetary policy Canova (2012) defines Convectional monetary policy as the interest rate policy set by central bank to achieve low and stable inflation. The central bank offers funds through buying or selling of securities to banks and interbank market with short-term interest rate to quantify economy reliability. The securities influence the reserve level within bank’s system. Normally, the fluctuations amount in the reserves is not an aim of the policy itself but rather by-product. Instead, they are used as a means to attain the change in interest rates to bring the desired economy impact (Borio 2010). The challenge of convectional policy The global economy crisis has challenged conventional monetary policy effectiveness since it does not prevent the occurrence of asset market bubbles Canova (2012). It is also posed with a challenge to tackle the post crisis results to stabilizing the economy. Since market interest rate are based at zero or close to zero with cash hold by agents being non-interest, nominal interest rate advocated by the policy becomes in effective. Therefore, Quantitative Easing (QE) was brought in to change the approach and focus on quantity variables (Canova 2012). The difference policy between convectional and Quantitative Easing Convectional monetary policy is based on intellectual development unlike Quantitative Easing policy which is on practical Reponses. Quantitative Easing also subjects its efficacy on central bank’s intense interest which is not the case on convectional monetary policy. Convectional monetary policy works with substantial evidence to assess economic change effected by short term interest rates in place. Quantitative Easing, such knowledge is not required or rarely used (Joyce et al 2012). Quantitative easing (QE) Quantitative Easing is defined by Canova (2012) is the government policy to introduce new currency in circulation through central bank. It was first implemented in Japan to counter the bursting asset market bubble and the deflationary pressures in 1990’s due to global economy crisis. This was necessitated by the failure of convectional monetary policy to effectively tackle the economical crisis (Borio 2010). Japanese government implemented Quantitative Easing policy to maintain zero interest rate in order to lowering the yield curve. The Japan bank has successfully applied it to sustain it economy thus making other countries banks like US, UK, and Euro area follow suit (Joyce et al 2012). Quantitative Easing normally, is through buying and selling of government securities like bonds and other assets so as to boost economy growth and end deflation. The central bank aims to improve the level of money reserves through buying government securities from other banks with zero interest rate. The move would remove deflation forces when the asset prices are raised. The purchase of variety of government securities with long term interest rates significantly has a long lasting impact on the economy (Borio 2010). Even though, recovery of the world economy has remained weak despite Quantitative presence does not disqualify its effectiveness. May be would be because of lack of sufficient scale, lack of proper measures or its effects are limited. In conclusion therefore, central banks need to improve their macroeconomic system to support the Quantitative Easing in stimulating economic growth and ending deflation (Joyce et al 2012). The impact of Japanese fiscal policy on Japan’s government debt According to Kuttner & Posen (2002), the Japanese government adopted a fiscal policy with the aim of increasing of dealing with its state of deflation. The policy was aimed at increasing government revenue. This policy was considered ineffective since it resulted to more economic stagnation and eventually increased the government debt rather than reducing it as anticipated. The public debt increased because instead of reducing the public expenditure the taxes remained the same. This rendered the policy ineffective because the government had to increase external borrowing to be able to increase their expenditure since the government experienced a budget deficit. The collapse of the asset purchase fiscal policy aimed at increasing the base money also resulted to increase in government debt. The predictions of standard economic theory and the actual level of interest rates in Japan The predictions of standard economic theory for the increase in government debt on Japanese interest rates is that the interest rates would be lower when the debt is higher so that the public is attracted to invest more and thus increasing government revenue making the government able to pay off its debt. This is because increase in government debt results to rise in output. The actual interest rates are at zero percent. The Japanese Government has a far higher level of debt than the governments of Greece, Italy, Spain, Portugal or Ireland yet it does not affect their confidence and rising interest rates because they borrow from IMF and World Bank at very low interest rates then lend to developing countries at a higher interest rate such that their debt does not affect their economy. Causes and implication for the appreciation of the Japanese yen Hamada et al (2011) point out that, the value of the Japanese yen is dependent on the rate of interest rates in the country, that is why Japan has been maintaining their interest rates as low as possible. The value is affected by the forces of demand and supply of the currency. Therefore the factors affecting demand and supply are the ones that determine the value of the currency; whether it appreciates or depreciates. The value of the Japanese yen affects the level of economic growth of the nation. The Yen has been appreciating due to the declining costs of production which has been so persistent because of the consistency in the trade surplus. The yen has been in constant appreciation; the investors observed this trend and speculated further increase in the value of the Japanese Yen so that they increased their buying of the yen resulting to the appreciation in value. Carry trade which occurred after the 2008 global financial crisis is another cause of the appreciation in the Japanese Yen. Before the crisis the Japanese Yen had very low interest rates such that other used it to purchase other currencies that had higher interest rates. Carry trade was aimed at raising the exchange rates of the pounds and the dollar thus depreciating the Japanese Yen. People responded to this by selling out the Yens they held and purchasing more dollars and pounds, later due to the effects of the crisis the current accounts were considered important in setting the exchange rates this and the carry trade became less important such that people started selling their dollars and pounds to acquire more Japanese yen resulting to its appreciation (Hamada et al 2011).The appreciation of the Japanese Yen makes their exports expensive making it hard for the exporters to export much. There has also been an increase in the inflation rate due to the increase in the value of imports and increased demand for Japanese products. The country has experienced stagnating growth in the economy due to the appreciation of the Yen due the increase in the exchange rates. ‘Abenomics’ and its prospect for successes Abenomics refers to an economic policy developed by Prime Minister Abe aiming at ending deflation in Japan. It states that the capability of success and failure of Prime Minister Abe is determined by the success and failure of the Abenomics policy. Abenomics is also known as “Three arrow” with three policies including flexible fiscal policy, bold monetary policy and new growth policy. In addition, the three arrows are significant in support of countries growth, lower monetary policy and sustain long –term economy. This policy can be applied in Japan to reduce deflation, stabilize Japan’s economy by standardizing prices and reduce the rate of unemployment (Fund 2000). The relevance of economic problems and policies Just like Japan, China, USA and Australia have developed economy and facing similar a challenges Japan and thus can apply similar policies in dealing with this problems. This makes the economic problems faced and the policies adopted by Japan so important to Australia, China, USA and other similar economies. Japan is challenged in its debt ratio which is at a very high percentage and has increased due to Japan’s attempts to encourage its economic growth after being through an economic crisis. Thus opted for borrowing externally to spur up the growth this resulted to the debt ratio problem which is a good lesson to the economies making the problem and the strategy implemented to solve important to these countries. Japan’s economic problems and policies are important to USA because the Japan operates so actively in their financial market in order to improve their competitiveness in the export market therefore any problems they face or policies they implement have an impact to their economy too (Nelson 2011). Japan is the third largest economy, before the world global financial crisis it was already dealing with problems in its own financial system and even with crisis the economy did not collapse because they were able to adopt policies for dealing with the crisis. Japan though is not alone in problems such as ageing population, disaster management; fiscal deficits because they are similar to what US and Australia are facing but has managed to deal with them thus US and Australia can also learn from them and apply their methods to solving their problems. China is the major exporter to Japan; this makes Japan’s economic problems and policy important to China because they also affect her economy (Kuttner & Posen 2002). Conclusion Conclusively, the bank of Japan adopted fiscal policies to assist in dealing with deflationary state of the economy. These policies were not so effective because instead of increasing government expenditure by increasing base money through increased purchase of assets it resulted to an increase in national debt. References Borio, C & Disyatat, P 2010, Unconventional monetary policies: an appraisal, The Manchester School, 78Iss s1, p. 53-89. Buiter, H. 2003. Deflation: prevention and cure (No. w9623). National Bureau of Economic Research. Canova, F & Ferroni, .F 2012, the dynamics of US inflation: Can monetary policy explain the changes? Journal of Econometrics, Vol 167, Iss 1, p. 47-60. Fund, I. 2000. Quarterly Report. State of Connecticut, Treasurer's Office. Hamada, K, Kashyap, A. K., & Weinstein, D. E. 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