Friday, December 28, 2012

Trust not in Shinzo Abe, ye monetarists!

Monetarists are an innocent lot. American bloggers, op-ed writers, and economists seem quite taken in by Japanese Prime Minister Shinzo Abe's promise of a grand monetary experiment. Abe is threatening to revoke the Bank of Japan's independence, forcing those recalcitrant hard-money-loving inflation hawks to set a hard target of 2% inflation or higher. To an American monetarist, this is really Christmas. Finally, we get to actually test the hypothesis that a central bank can hit an inflation target if it really puts its mind to it! Finally, we get to see the ultimate two-men-enter, one-man-leaves doomsday showdown between the immovable object of Japan's implacable deflation and the irresistible force of Print Money And Buy Stuff!

But it is not to be. Shinzo Abe is not the Jesus of monetary policy. American monetarists, I feel for you - I would love to see the idea of monetary policy dominance put to a stark test - but I just don't think it's going to happen.

You see, unlike most Americans who weren't watching back in 2006-2007, I remember Shinzo Abe's first term as PM. So I know what a walking facepalm this man represents. A brief refresher course: Abe's agricultural minister killed himself after a corruption scandal, and another of his cabinet ministers resigned after another such scandal. His health minister, Hakuo Yanagisawa, managed to hang on despite a wave of negative publicity after he called women "baby-making machines".

Abe is mainly interested in social and cultural issues. He is the Japanese style of socio-cultural conservative, sort of a Newt Gingrich type . As prime minister in 2006-7, he enacted a law requiring public schools to teach "patriotism",  mounted a vigorous denial of Japan's WW2 "comfort women" sex-slavery, gave gifts to the nationalist Yasukuni Shrine (angering China), and pushed to de-emphasize Japan's WW2 war guilt in school textbooks. His lifelong quest has been the revision of Japan's "pacifist" constitution to allow Japan to have a normal military.

I of course don't mean to imply that Abe's cultural conservatism makes him unlikely to experiment with monetary policy (unlike in America, in Japan "hard money" is less of a conservative sacred cow). Instead, what I mean is that Abe really just does not care very much at all about the economy. I mean, of course he wants Japan to be strong, and of course he doesn't want his party kicked out of power. But his overwhelming priority is erasing the legacy of World War 2, with the economy a distant, distant second.

This is why Abe allows himself to be surrounded by corrupt and incompetent people. He is entirely focused on his cultural conservative quest. The other day Abe called Obama "Bush". He just deeply, truly, does not care about stuff that does not involve boosting Japanese nationalism.

So why is Abe making all this noise about revoking central bank independence, setting hard inflation targets, etc.? I have a hypothesis: He is talking down the yen.

Since Abe was elected in a landslide a couple weeks ago, the yen, which had been at historically high levels, has plunged. (Update: from Matthew Boesler at Business Insider, here is a chart of the yen-dollar exchange rate since the LDP returned to power:
USD/JPY H2 2012


This is bound to give a (possibly temporary) boost to Japan's beleaguered exporters, who have been suffering quite dramatically under the strong yen. Remember, Abe's LDP, which ruled Japan for 55 years, has always been closely connected with export manufacturers in the so-called "iron triangle". The LDP, which thrived in the 60s, 70s, and 80s, has always been a mercantilist outfit, weakening the currency to pump up exports, using the surplus from exports to support Japan's corporatist social model in the so-called "two-tiered economy". In Japan's days as a high-quality low-cost export powerhouse, this worked marvelously and kept everyone happy, allowing the LDP to keep power for generations. The recent strength of the yen, however, has been looking like the final nail in that system's coffin.

By making lots of noise about revoking the BOJ's independence, Abe is trying to convince foreigners that inflation is on the way, thus sending the yen south. Basically, he is taking a page out of the LDP's old playbook - weaken the currency, pump up exports. Sure, it's not a sustainable strategy, but Abe doesn't need it to be sustainable; he just needs it to give the economy a fillip for long enough to let him complete his precious revision of the Japanese constitution. After that, he couldn't care less about what happens to the economy. It's a cursory, stopgap measure. To Abe, Japan's pride as a nation is infinitely more important than the fatness of its people's wallets.

Abe is not exactly trying to keep this strategy a secret, saying that counteracting the strong yen is a top priority.

So what does this mean for monetary policy? It means that Abe is targeting exchange rates, not inflation (or NGDP). He'll do what he has to do to tweak foreign expectations enough to keep the yen weak, but he won't actually follow through and revoke BOJ independence. And even if by some miracle he does revoke BOJ independence, he won't insist on a hard inflation target. A non-independent BOJ wouldn't be controlled by Shinzo Abe, it would be controlled by the Ministry of Finance, and those people are just as likely to fear the peril of hyperinflation.

Expect Abe to continue making noise at the BOJ, and expect to see some token BOJ response, i.e. a bit more quantitative easing. If the yen starts rising again, expect Abe to switch gears and start talking about (or actually carrying out) currency market intervention of the type carried out in 2004. Essentially, he will continue the current talk of radical monetary policy experimentation precisely as long as he thinks it's holding down the yen, and then abandon it for a different mercantilist stopgap. Do not expect any real action against the BOJ.

OK, maybe I'm wrong. I'm no expert in Japanese politics, just a guy who has been reading about the LDP for a long time. If Abe follows through on his radical monetary proposals, I'll gladly eat crow. But think of it this way. If a British guy came up to you six months ago, brimming with optimism that Vice President Paul Ryan would enact his famous Ryan Plan and save the U.S. from ballooning budget deficits, what would have been your response? That's how I feel when I see people put their trust in Shinzo Abe.

I hope I'm wrong. I'd love to see a bold monetary experiment. But I'm pretty sure I know these LDP jokers, and I'm pretty sure they're not going to deliver in the crunch.

Update: And now today, via the WSJ, I see that I'm completely right about the LDP's economic philosophy. Observe:
Japan's new finance minister upped the ante in the country's war of words against the strong yen, lashing out at the U.S. and Europe for letting their currencies weaken dramatically and calling on the U.S. to strengthen the dollar. 
The tirade from Taro Aso, Prime Minister Shinzo Abe's point person on currency strategy, underscores the increasingly pugnacious stance of the fledgling Abe government... 
"The U.S. ought to do its job and make the dollar strong. And what about the euro?" Mr. Aso said Friday... 
A procession of Japanese executives and politicians have bemoaned the yen's strength, blaming it for a loss of competitiveness, dwindling earnings, bankruptcies and the relocation of operations abroad... 
The dollar has recently staged a sharp recovery, as Mr. Abe's pledge to strong-arm the Bank of Japan into easing monetary policy to weaken the yen has driven investors to sell off the yen. (emphasis mine)
Oh yeah, they're really thinking a lot about inflation rates and money demand and the Zero Lower Bound. Sure.

Update 2: I think Reddit puts it very succinctly by saying: "Shinzo Abe isn't reading Scott Sumner, he just wants a return to Japanese mercantilism." That's exactly it. A mercantilist in monetarist's clothing.


  1. Gotta make explicit something you only implied (and which I've really heard very little talk of since the election) —

    This does not bode well for the China-Japan relationship, especially if growth weakens in China. Abe and his guys looking, it seems, for literally any excuse to butt heads with China.

    Also, isn't it kinda funny how political parties that call themselves the "liberal democratic party" very often are the opposite? In Russia, the Liberal Democratic Party are hardline nationalists. In Japan, they are nationalists. Here in Britain, the "Lib Dem" Party is propping up a Conservative austerity government.

    1. Maybe we're the ones who have it backwards? :/

    2. The less said about the Liberal Democratic Party of Russia, the better >_<
      But I think that it's name is just a relic of the time of its creation (when everything Liberal, Democratic, or better yet Liberal Democratic was popular in Russia) rather than a deeper reflection of this party goals (disrupting left-wing parties votes) and rhetorics (targeting right-wing nuts).

  2. Talking down the yen and targeting exchange rates looks like a win from my perspective for the monetarist crowd. After all, isn't that what Lars Svenson did?

  3. Ben Johannson9:03 AM

    It appears an export-focused policy has been in the works for some time. Japan's dollar reserves at the Fed have been increasing for several months, so they're buying up dollars from somewhere without announcing it. Increased fuel imports since they shut down their nuclear industry are also helping to weaken the currency.

    I'd really like to understand monetarist thinking on inflation. The BoJ hasn't been able to maintain its current target of 1%, so how will changing to a 2% target be more effective? Monetarists don't seem to realize that because the central bank is required to set the overnight rate, it must ultimately target the price of reserves and therefore has very little control over quantity.

  4. but doesnt he get to nominate the BOJ head in the spring? If the BOJ does not follow through with some easing, the weak yen will be but a blip by next year, so it seems to me if the goal is a permantly weak yen, he will have to push the BOJ for much more inflation. Maybe Abe stumbled on the right solution, for the wrong reasons, but a higher inflation target is still a good way to weaken the yen.

    1. yes, he nominates the new BoJ head before the important elections in noon. Then we'll see how the new governor talks and behaves.

      I guess Smith could be right, but Abe specifically talks about deflation and under pressure after its head was fired, the BoJ is talking about reviewing its inflation target.

      "If a British guy came up to you six months ago, brimming with optimism that Vice President Paul Ryan would enact his famous Ryan Plan and save the U.S. from ballooning budget deficits, what would have been your response?"

      Except Abe is promising a fiscal stimulus of 119 billion dollars while Ryan was in favor of austerity as the magic elixir. Ryan has also been a hard money fundamentalist so would never accuse a central bank of being to tight with its monetary policy.

  5. You are aware that exchange rate targeting is an effective substitute for NGDP targeting for an open economy, aren't you? If he wants to target JPYUSD at 65, great. That works out fine.

    1. Ben Johannson11:30 AM

      That depends on whether one thinks NGDP targeting works.

    2. Admittedly I didn't remember Abe's previous term until my Korean friend voiced his displeasure. I have an alternative theory of Abe's intent.

      He will loosen monetary policy. In the short term the mechanism is almost irrelevant (exchange rates, higher inflation target, NGDP target, politicized central bank).

      He will end the nuclear power moratorium. Nuclear is by far the most attractive power source in Japan, which is currently paying through the nose for imported LNG. Hopefully Japan will fund more pilot advanced reactor plants, or at least decommission Generation II plants for Generation III+ or IV plants.

      He will push his cultural conservative/nationalist agenda. Like you said, this is his passion. Tensions with China and Korea will skyrocket over territory disputes, revisionist history, and a return to militarism. Abe will try to make Japan militarily self sufficient again, for the first time since 1945 (IIRC this will require constitutional change). He'll be pretty successful in these goals if he delivers on the first two items; nothing delivers electoral victory like a strong recovery.

    3. @Ben

      No, it doesn't. Exchange rate targeting is a substitute policy to NGDP targeting whether or not you think NGDP targeting works. I think a NGDP target would be as close to an optimal policy as you can get for a large economy, but that has to be confirmed with evidence.

      That being said, I think there is ample evidence that liquidity traps are phantoms, i.e. monetary policy does not weaken when interest rates approach zero unless it makes policy makers uneasy. Thus in the short term any policy framework that gets policy makers to credibly commit to easier policy is an improvement over the status quo.

    4. Ben Johannson12:23 PM


      You wrote that tergeting exchange rates was an "effective" policy. That was what I responded to. I fully expect NGDP targeting to be ineffective, given the central bank does not control the money supply and cannot target quantity.

  6. Anonymous11:46 AM

    I like where you are going, but perhaps it isn't the full picture, and there is a deeper hidden agenda? What if Abe is more of a Strawman PM rather than a real PM? LDP knows they can win on a platform of weaker yen - which has been talked up from the time the election was called a few months ago. He goes in with hardline policy, but really it is all smoke and mirrors, as you pointed out. By summer the yen has strengthened and Abe is out by the Fall, but LDP are back in power and can continue to put someone else in place that they really want to be the PM. Who that person is, I don't know, but I would guess someone unsavory enough that LDP was not confident that they could win the recent election with - someone more scandal tainted than Abe, which in Japan isn't that hard to find!

    Alternatively, Abe's weak yen talk works well enough to get some Japan Inc firms back on track, coupled with a strengthening global economy in 2013 (not that I am super optimistic about global prospects next year) and the yen then continues to weaken naturally without inflation ever hitting 2%.

    Regardless of what happens, if Abe does actually try to meddle with BOJ independence, it certainly would be a significant point in history for Japan's economic downfall.


  7. Heh. Politics trumps economics. As usual.

    1. Ben Johannson7:01 AM

      As usual, economics is politics.

  8. Why not just talk down the yen instead of discussing the BoJ and deflation?

    Wouldn't talking the yen still be good even if it was done by a rightwinger? Would you feel differently if a lefty was talking down the yen/criticizing the central bank? I really really wish Obama would have said loud and often during the camping that A) "I'm going to enact a fiscal stimulus in the hundreds of billions B) "Bernanke and the Fed are doing a crappy job and I'm going to appoint a new chairman.

    Think of Romeny's confusion over bashing China's currency manipulations and then criticizing Bernanke.

    1. Why not just talk down the yen instead of discussing the BoJ and deflation?

      Because talking down the yen directly makes other countries angry.

    2. Talking down the yen would probably make the US particularly angry, when you consider that "currency manipulation" actually became a hot political topic in the 2012 election.

      I'm with Casey, though - I think he'll push for an end on the nuclear moratorium. It's hard to do a "low-yen" policy when you're paying through the nose for imported energy because of it.

    3. "when you consider that "currency manipulation" actually became a hot political topic in the 2012 election."

      Yeah but the U.S. never does anything about it. It's all kabuki, just as Abe's promises to end deflation could just be more kabuki.

      Funny that the neutral pacifist Swiss have more cajones than the Japanese in talking down their currency.

    4. "Currency manipulation" is politically significant because "China stealing our jobs" is a big deal and opposing currency manipulation is a way of fighting that which is relatively palatable to mainstream politicians. Japan used to be the scary oriental job-stealing boogeyman, but I don't think they really fill that role anymore.

      Of course, countries can and do get pissed off at things without it making its way down to political debates among the general population.

  9. Don't worry about whether or not Japan is going to engage in a monetary experiment. You may be about to witness a once in a lifetime fiscal experiment in real time with the fiscal cliff.

    1. Ben Johannson7:05 AM

      Europe has been conducting that experiment for three years. Our "leaders" simply refuse to learn the lesson, which means that rather than conducting a unique experiment, we're just stupid.

  10. Anonymous4:08 PM

    I think all the stuff with Abe and BoJ is, as Noah states, about talking down the yen without actually directly talking down the yen. But forget about monetary policy (which can't do anything else). No-one here is talking about the new fiscal stimulus proposed - the supplementary budgets - this is what will be interesting.

  11. Japanese politics is infantile. There are no "issues" or policy debate. It's all about the trough, just like Italy or New York. In Japan, politicians are considered low status and disreputable. The Western media covers Japanese elections as if they mattered.

  12. Scandal after scandal, socio-cultural conservative, trying to erase the legacy of the previous war, the economy being not top priority, does not care about stuff that does not involve boosting nationalism, weakening the currency to pump up exports...

    Maybe you are too young to remember, but these keywords brings one former U.S. Presidents's name to my mind. No, not George W. Bush, but Ronald Reagan. So maybe monetarists can get along with Abe, after all.

    1. Haha I made exactly that point on Twitter yesterday!

      But remember that Ronald Reagan's monetary challenge was inflation, not deflation, and the two may not be symmetric at all...

    2. What about Nixon? Burns's attempt to ingratiate himself to his boss helped lead to the inflation of the 1970s.

      What do monetarists think about Abe's promises of fiscal stimulus?

  13. The LDP are not the most clear-thinking crowd on the planet, but the comparison to Paul Ryan seems out of place to me. Ryan's just a congressman for the party that lost the elections. Abe on the other hand just won the elections (well, strictly speaking at least) as prime minister, and the people support more vigorous action against the paranoid dust-bags at the BOJ. What other "top-gap" measure will Abe have at his disposal if the promised action against the BOJ fails to materialize? Once the markets catch wind that it was all a hoax, the Yen should shoot up, leaving Japan's export industry exposed and the LDP having much explaining to do.


      "It would be interesting to know which monetarists Noah is talking about. (The only “innocent” monetarist Noah links to is Matt Yglesias, who is neither innocent nor a monetarist.) Like Noah, I’ve been skeptical of the intentions of the Abe government, noting that bond yields don’t show much sign of inflation expectations. On the other hand the yen has weakened, so there’s likely to be at least a modest change in policy. But I put faith in markets, not politicians."

      Maybe Yglesias and Smith could have friendly wager?!?

      What would need to happen for Smith to admit his hunch was wrong? What would the terms of the bet be? How high would inflation expectations need to reach by what date?

  14. Mistaking Obama for Bush? Many of Obama's policies aren't that different from G.W. Bush's--check out what Glenn Greenwald has written on this.

  15. Noah is right: there's no innovation in Japan about doing anything radical. That's their mindset. Having said that, it shocked me when Shuji Nakamura won a unprecedented award for inventing a blue laser, when the law was clearly against him (See ; the parties settled btw for a pittance, only $9M, but it was a shocking legal decision from the hide bound JP court system).

  16. Good post Noah. Don't worry about that big bully Scott Sumner; he has no problem with young people commenting on monetary policy, so long as they agree with his conclusions.

  17. US doesn't care about Japan taking down the yen, as long as they do it by buying US Treasuries.

  18. I think exchange rate targeting has been advocated for decades now as a way to exit a liquidity trap for a small open economy.

    Obviously there's nothing particularly "market monetarist" about this, but I can't see why it has to be an "unsustainable mercantilist stopgap". Japan goods&services BoP has been negative for 2 years now, it has a LOOOOONG way to go before getting "mercantilist".

  19. Anonymous10:09 AM

    Obama (and DOD) is at least partially responsible for bringing Abe. When they refused to re-negotiate a US base deal in Okinawa with his predecessor, the pro-America rightwing media and pundits panicked (or so pretended) that the alliance was at jeopardy, we lost friendship with America, etc. etc. In a long shot, that led to the downfall of the previous Japanese PMs of the Democratic Party. Abe is bent on introducing the collective self defense which will enable force projection beyond its borders to such locations as Iran, Afghanistan, or maybe Taiwan. Obama is unfortunately stupid enough to welcome it because of his ideological fixation to be remembered as a "tough" Democratic president vis a vis China.

  20. Anonymous1:24 PM

    I too remember the previous Abe, who left office with public support at historic lows. How short peoples' memories are. Alright, so the BOJ have moved, but Abe's right-wing agenda remains, probably to be revealed after the upcoming Upper House election in July. Here is some background on the right-wing associations of his cabinet: