Macroeconomic Stability and Policy: Japan - Example

Macroeconomic Stability and Policy (Japan) Name: Course: Instructor: May 10, 2014 Japan’s Economic Performance According to the International Monetary Fund (IMF), Japan has the third largest economy globally in terms of nominal Gross Domestic Product (GDP). In terms of purchasing power parity (PPP), Japan ranked fourth and in 2012 and ranked second in terms of per capita GDP with $35,855 (Cargill, Hutchison & Ito, 2003). Japan has experienced two decades of stagnation since 1990’s to 2000’s terming them as the two lost decades. In recent times, Japan ranks as the world’s largest creditor running huge international surpluses and having international net surplus of considerable amounts. By the year 2010, the country possessed in excess of 13.7% of all private financial assets globally ranking as number two with an estimated 14.6 trillion dollars. In 2013, out of five hundred Global Fortune companies in the world, sixty-two of them were in Japan (Cargill et al., 2003). In the last decade, Japan's economy has not experienced meaningful growth. There has been stagnation of the economy in the last decade particularly because the government of Japan has executed measures aimed at keeping inflation levels at a constant zero (Coenen & Wieland, 2003). In recent reports by the IMF, the year 2011 saw Japan experience a 2.3 percent contraction in the gross national product in all the four quarters. The nominal GDP contracted at a rate of 3% annually and deflation rates recorded at 1%. Since the year 2007, the Yen value has dropped from five hundred and fifteen trillion Yen to four hundred and seventy trillion Yen in 2009 as well as in 2011 (Coenen & Wieland, 2003). In effect, the Japan economy seemed to enter the third lost decade at the end of 2011 and start of 2012. In effect, the Bank of Japan announced an intentional expansionary policy aimed at increasing spending, inflation and thereby easing on the stagnation (Coenen & Wieland, 2003). Stabilization Policies It's notable that over the last decade mostly from the year 2000, the Bank of Japan (BOJ) has been keen on defending its economy from any form of inflation (Kuttner & Posen, 2001). In effect, the level of inflation in the last decade has remained as close to zero as possible. In effect, the economic recovery experienced since 2005-2009 were negated by the GDP and GNP contractions that occurred in 2011 and the start of 2012 (Kuttner & Posen, 2001). In that respect, the economy has remained stagnant. Towards the end of 2004, the BOJ implemented quantitative easing in order to induce a stimulus in the economy. However, the BOJ was quick to withdraw the stimulus in the same year when inflation (rising prices) started to emanate (Kuttner & Posen, 2001). Fiscal policies were applied in response to the deflationary or no growth doldrums that have been characteristic of the last decade. In the wake of 2012, Rinban that were bond purchase programs were floated with the purpose of buying all government bonds floated by the Japanese government for the whole year (Kuttner & Posen, 2001). In this respect, the Bank of Japan committed itself to an expansionary monetary policy that aimed at printing more money in order to help finance the increased government spending. The combination of the expansionary monetary and fiscal policy was a form of an austerity measure that was to help the government pay the huge outstanding interest payments on debts as of the year 2012. It is notable that as at the end of the year 2012, international debt stood at two hundred percent of the GDP (Kuttner & Posen, 2001). In effect, the market responded to the reflationary policies positively recording impressive and favorable performance of the market. The Nikkei, Stock Market Index for Japan, has constantly risen to record high of eight percent in early 2014 (Krugman, Dominquez & Rogoff, 2008). The Yen has reported a sharp decrease in its value weakening against other major currencies – by over three percent against the American dollar and over five percent against the Euro. In response, the weak Yen has reversed the sharp decline which is an austerity measure improved the traded goods sector and thus improving its outlook. The Bank of Japan also instituted measures in 2011 to boost the equity prices thus improving the household balance sheets (Krugman, 2008). This spurred domestic consumption and improved the status of domestic companies. In February of 2014, Japan faced a rather sharp decline in its exports and indications of a weaker economy was imminent. In effect, as an austerity measure, the Bank of Japan instituted an increase in the level of government bonds (JGB’s) that it aimed to purchase this year with a target of a 1% inflation rate (Krugman, 2008). Economic Theory (Monetary and Fiscal Policy) Japan has instituted both monetary and fiscal stabilization policies in the past decade. Fiscal policies instituted by the fiscal authority aim at increasing government spending and /or changes in the taxation policies. On the other hand, monetary policies are instituted by the monetary authority with the aim of causing changes in interest rates and/or the money supply (Lambertini & Rovelli, 2003). Fiscal policies have a lag time before meaningful indicator changes become evident. However, central banks such as the Bank of Japan, which operate as monetary authorities, have a level of independence. Thus, indicators of change due to changes in the money supply or the interest rates are felt almost immediately (Lambertini & Rovelli, 2003). The aggregate supply (AS) curve of the economy determines whether fiscal or monetary stabilization policies are effective. The AS curve shows the interaction between price levels and the level of real GDP supplies in cases when quantities supplied of other determinants are constant. The AS curve tends to be inclined positively in such a way that, as the price level rises, the quantity supplied also increases(Lambertini & Rovelli, 2003) . If the AS curve flattens, the GDP output could be increased largely with a small level of inflation. In effect, expansionary monetary and fiscal policies tend to raise Aggregate Demand (AD) curve. The result is low inflation levels and huge increases in the level of GDP. If the AD curve is steep, the level of prices are sensitive to changes the GDP output. In effect, expansionary fiscal and monetary policies have a large effect on the real GDP. AD affects prices (inflation) in the end when the curve is steep and GDP output in the short run when the curve is flat (Lambertini & Rovelli, 2003). The lag prevalent in the economy lies in the relationship between potential and actual GDP in a business cycle. When recession and stagnation occur in an economy, policy makers will develop austerity, fiscal and monetary measures to alleviate the situation and prevent economic downfall (Lambertini & Rovelli, 2003). In cases where there is too much lag in the period between the recession and stagnation and the implementation in monetary and fiscal policies, then policies made thereafter may not achieve the desired effect. In fact, they may over-stimulate, under-stimulate or destabilize the economy at the time of recovery. In the last decade, Japan has responded to recessions and stagnations with higher taxes and huge government spending. The fiscal policies totaled to a high 1.1 trillion Yen aimed at increasing domestic demand and help major companies out of insolvency (Lambertini & Rovelli, 2003). In effect, the policies left the government heavily indebted with a debt burden of over two hundred percent of its national GDP and thus leaving the economy with few options to manage its situation (Lambertini & Rovelli, 2003). Monetary policy involves either the control of the interest rates or the money supply. Recently, BOJ adopted the money supply over the interest rates stance that they have adopted over the last two decades. However, money supply as a measure of guiding monetary policy is much more difficult since demand for money is not predictable and thus fluctuations in interest rates become inevitable (Lambertini & Rovelli, 2003). This makes decision making difficult. It is notable that Japan did not monitor money supply growth over the last two decades and thus difficulties in managing .The move to print additional money may cause the value of the Yen to fall much further than expected. In this case, the low value of the Yen may cause current investors in the financial system to withdraw. Additionally, domestic investors would suffer from money printing since their equities will reduce their value (Lambertini & Rovelli, 2003). Conclusion The past decade in the Japanese economy has suffered stagnation. This has been particularly so since the government together with the Bank of Japan executed defensive monetary and fiscal policies aimed at safeguarding inflation and price levels. Particularly, the level of inflation has been maintained at zero for the better part of the last decade. In effect, Japan has instituted several monetary, fiscal and austerity measures aimed at correcting the stagnation and recession of the economy. Quantitative monetary policies used in 2004 caused a rise in inflation and thus prompting their withdrawal. Starting the year 2011, the BOJ instituted expansionary monetary policies aimed at printing more money. Expansionary fiscal policies were also instituted aimed at increasing the level of government spending. However, the move seemed to cause large increases in international debt, which amounted to two hundred percent of the national GDP. Economic theory tends to explain this disparity in the targeted results and the actual outcome. Monetary and fiscal policies, whether contractionary or expansionary, tend to have discordant effect in cases of large time lags between economic instability and the implementation of the policy. With the current implementation of money printing in February this year, the economy of Japan is set to expand due to a reduced value of the Yen that will favor exports and imports. In effect, the allowance of low levels of inflation for the first time allows the growth of the economy and away from the stagnation levels. The strategy may also prove to discourage local and foreign investors if the levels of inflation soar to higher levels in the future. References Blanchard, O., Dell’Ariccia, G., & Mauro, P. (2010). Rethinking macroeconomic policy. Journal of Money, Credit and Banking, 42(s1), 199-215. Accessed May 10, 2014 Cargill, T. F., Hutchison, M. M., & Ito, T. (2003). The political economy of Japanese monetary policy. MIT Press. Accessed May 10, 2014 Coenen, G., & Wieland, V. (2003). The zero-interest-rate bound and the role of the exchange rate for monetary policy in Japan. Journal of Monetary Economics, 50(5), 1071-1101. Accessed May 10, 2014 Kuttner, K. N., & Posen, A. S. (2001). The great recession: lessons for macroeconomic policy from Japan. Brookings Papers on Economic Activity, 2001(2), 93-185. Accessed May 10, 2014 Krugman, P. R., Dominquez, K. M., & Rogoff, K. (2008). It's baaack: Japan's slump and the return of the liquidity trap. Brookings Papers on Economic Activity, 137-205. Accessed May 10, 2014 Lambertini, L., & Rovelli, R. (2003). Monetary and fiscal policy coordination and macroeconomic stabilization: A theoretical analysis. Università degli Studie, Dipartimento di Scienze Economiche. Accessed May 10, 2014 Read More