Daily Archives: April 4, 2013

Haruhiko Kuroda, the newly installed Bank of Japan governor, has offered the monetary equivalent of shock and awe. Under Mr Kuroda’s guidance, the BoJ now intends to hit a 2 per cent inflation target within the next two years; is committed to doubling the monetary base; is willing to buy bonds of all sorts of maturities; is accelerating its purchase of risk assets; and has gone considerably beyond already elevated expectations within financial markets.

In acting decisively, Mr Kuroda is following a well-trodden path: think of Paul Volcker and his battle against inflation at the beginning of the 1980s or Alan Greenspan and his tussle with equity markets in 1987. Moreover, there has been a willingness to learn from the excessive caution of the past. By buying bonds of more or less all maturities, the whole yield curve has come down. By openly committing to a higher inflation objective, it’s clear that monetary conditions will remain loose for a prolonged period of time. Meanwhile, Shinzo Abe, Japan’s prime minister, seems keen to avoid a UK-style inflation trap, emphasising that a healthy escape from deflation requires not just higher prices but also higher wages.

So far, so good. The commitment is most definitely there and the ambition has now been well-defined. Yet Japan is not yet out of deflationary trouble and, even in the event of the monetary equivalent of the Great Escape, it might still all end in disappointment.

The first – and most obvious – problem is that Japan’s difficulties do not reflect an absence of monetary and fiscal stimulus alone. Offshoring, ageing, the unproductive use of women in the workforce and an acutely cautious attitude towards immigration have all played their part in constraining Japanese growth during its two lost decades. A wave of the monetary magic wand cannot fix those problems.

The second difficulty relates to leakage in what is known as the carry trade, in which an investor borrows money at a low interest rate in order to invest in an asset that is likely to provide a higher return. It may be that borrowing costs in yen are now remarkably low relative to Japan’s own history but, over the past two decades, they have always been low relative to interest rates elsewhere. Over that period, attempts to boost the Japanese economy have too often seen the benefits spilling over to other parts of the world, creating unwanted hot money inflows, overvalued currencies and unsustainable financial bubbles, even as the Japanese economy has remained trapped in a deflationary hole.

The third challenge relates to the performance of the yen and, more generally, the transmission mechanism of monetary policy. There’s a potential inconsistency between the Japanese view of monetary stimulus (it lifts domestic demand and rebalances the economy towards domestic consumption) and the – whispered – UK view (it lowers the exchange rate and rebalances the economy towards exports). In the UK’s case, the rebalancing never came to pass and, arguably, a lower level of sterling only led, via higher import prices, to a squeeze in real wages. In Japan’s case, previous experiments with QE – admittedly not on the same grand scale – mainly served to boost exports without any significant impact on domestic demand. In a world where other nations are struggling for growth, a yen-induced export-led Japanese economic recovery might not be enthusiastically received. And, despite Mr Abe’s hopes of higher wages, it may be that rising import prices ultimately only serve to squeeze real incomes.

Mr Kuroda has got to first base. He has yet to score a home run.

The writer is HSBC’s group chief economist. His new book, ‘When the Money Runs Out: The End of Western Affluence’, will be published by Yale in May

The US monthly jobs report is eagerly anticipated for more than the insights it provides into the health of the economy. These days it also serves as an indicator of the direct impact of congressional dysfunction, the evolution of experimental policies from the Federal Reserve and trends in income inequality. So what should we look for in Friday’s data release?

Meeting the reported consensus expectation of 200,000 in new jobs in March would confirm that the US economy remains on the road of gradual recovery from the global financial crisis and the great recession that followed. But this would not be enough to overcome concerns about the too-tepid improvement and the possibility of another “spring swoon”, which Ben Bernanke, Fed chairman, recently cautioned against. (After a first quarter average of 262,000 last year, the three-month moving average plummeted to just 108,000 in June before picking up steam again.)

More generally, Friday’s data will tell us that, despite rising costs and risks, the Fed’s hyperactive policy stance is maintaining the economy’s lukewarm forward progress. Unfortunately, and as other data this week confirm (including two disappointing Institute for Supply Management readings), the central bank’s tools are still failing to take the economy to escape velocity, an objective explicitly mentioned in last month’s speech by Janet Yellen, Fed vice-chair. So do not expect a dramatic decline in the 7.7 per cent unemployment rate, barring an unfortunate continuation of the fall in the participation rate seen in the last few years.

Some might take Friday’s data as an indication that congressional dysfunction, specifically the impact of the fiscal cliff and spending sequestration, has yet materially to undermine the labour market. But they should not get carried away: the spending cuts stretch over a number of months; and the contractionary influence of the higher payroll tax has been offset by a decline in the household savings rate to almost 2 per cent, a level last seen in the middle of the previous decade.

On policy issues, also look for the report to fuel a debate that will only grow louder in coming weeks: when will the Fed start tapering its $85bn monthly purchases of securities?

For the Fed, this involves a delicate balance to avoid two extreme outcomes: “excessive” stimulus, which risks collateral damage and significant unintended consequences; and tightening “prematurely”, stifling growth and precluding the safe deleveraging of overindebted segments of the economy (also known as “the Japanese mistake”).

Judging from recent remarks, Fed officials believe that, even in a tapering mode, they would have multiple opportunities to get the balance right over time; and they would signal so by explicitly committing to readjusting the scale and scope of its purchases “as needed”. Others are less comfortable with the notion that the Fed can be appropriately adaptive when its instruments are blunt and market signals have been contaminated.

In addition, markets not only respond to Fed measures but also anticipate future actions. As such, there is a natural tendency for markets to extrapolate from even partial moves, rendering the cost of a policy mistake bigger (even if it is subsequently countered).

Turning to income inequality, do not expect signs of a substantial improvement. Youth unemployment (including February’s rate of 25 per cent for 16 to 19-year-olds) will remain at alarmingly high levels. There will probably be little reduction in the gap between the low unemployment rate for university graduates (3.8 per cent in February) and those without a high school diploma (11.2 per cent).

Finally, some may draw a favourable comparison between the US data and Tuesday’s announcement that eurozone unemployment has risen to a high of 12 per cent. To do so would be short-sighted. Such relative comparisons overlook the difficult realities facing the jobless — especially the long-term unemployed, and those who have dropped out of the measured labour force altogether. This is particularly the case when budget cuts continue to undermine social safety nets.

Indeed, the most important long-term conclusion that should emerge from Friday’s jobs data is that, notwithstanding a welcome steady improvement, the US (and most of the west) has yet to overcome fully a problem that eats away at productivity, human dignity and the social fabric of society. Hopefully, Congress will fully understand this — and act upon it.

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