Sunday, December 30, 2012

Should Japan "reflate"?

In Japan, the term "rifure" stands for "reflation" or "reinflation", meaning a (hypothetical) Big Push by montary policymakers to end the decades of deflation in that country. The question of whether Japan should "reflate" is the biggest question in Japanese macroeconomic policy circles.

Now, I've gone on the record as a skeptic regarding the power of central banks to fine-tune the macroeconomy. In that post, I mentioned the idea of an inflation "snap-up", where expansionary monetary policy suddenly and unpredictably pushes inflation from very low to problematically high. Also, I've cast doubt on the idea that Shinzo Abe, the current hero of the Japanese "reflationist" camp, is really committed to following through on the radical changes he's proposed.

Still, I think that if Japanese politicians and policymakers were willing to try a big push for reflation, it would be a good idea. I explain why in an article (in Japanese) published on the Japanese econ blog site Agora. Here is an English translation of my main argument:
[T]he gains [of an attempt at reflation] seem disproportionate to the risks. Reflation has the potential to help Japan solve three of its biggest problems at once: 1) the slow economy, 2) deflation, and 3) the huge national debt. Monetary easing will probably lower Japan’s unemployment a bit, and will also cause the yen to weaken, helping exporters. It will also erode the real value of the national debt, which at over 140% is the highest in the developed world. 
The only risk, on the other hand, is hyperinflation. How much should we fear hyperinflation? In terms of its effect on the economy, it is very similar to a sovereign default, which Japan is headed for anyway if it does not get its deficit spending under control. Hyperinflation destroys savings and causes economic activity to grind to a temporary halt; it usually lasts for about a year, before the government is forced to implement harsh austerity. After the end of hyperinflation, economies often recover strongly as economic activity restarts. 
In other words, hyperinflation is bad, but it is not the end of the world. Furthermore, it seems like an unlikely event. Hyperinflations are rare in history, and usually seem to coincide with severe disruptions to the real economy, such as wars.  
So when contemplating reflation, we must balance the likely possibility of three very important gains against the unlikely possibility of one bad but not world-ending loss. To me, the risk seems to be one worth taking.
Nobuo Ikeda, the prominent Japanese econ blogger who runs Agora and graciously published my piece, offers a rebuttal (also in Japanese). Here is a (rough) translation of his main counterargument:
[Noah is espousing] the "burn it down and start over" theory I often hear these days; but would the damage [from hyperinflation] really be finished in just one year? The bad debt problem in the 90s lasted ten! And in 5 years, recovery from the American financial crisis has not yet been achieved; in fact, the effects have spread to Europe. A Japanese financial crisis would be even bigger, and I fear the Japanese economy would never be able to regain its footing. 
As I showed in the hypothetical scenarios outlined in my book, the real danger of hyperinflation is not an economic collapse, but a financial one. If [nominal] interest rates soar [as they would in a hyperinflation], the national debt bubble will burst and most local banks will collapse...the crisis would be even longer-lasting than the one now facing Europe... 
As Niall Ferguson (whom Noah dislikes) has pointed out, many civilizational collapses begin with a financial collapse.
Basically, Ikeda argues that even if hyperinflation is unlikely, it is so catastrophic that we should not countenance even the smallest possibility of it happening. 

Well, I have three thoughts about this:

1. Niall Ferguson shows that financial collapses precede civilizational declines. Precedence does not equal causation. Remember, financial markets are forward-looking, so if people see a civilizational collapse coming, of course they're going to sell their assets; that doesn't mean a hyperinflation or default would have caused civilizational collapses where none occurred. If civilizations collapsed every time there was a financial crisis, then America would have collapsed after 1929, Germany after 1920, and Sweden after 1992. In other words, financial crises have predicted 10 of the last 3 civilizational declines. 

2. Looking at the list of past hyperinflations, I don't see any instance of monetary policy experimentation causing a civilizational collapse. In many of the cases, hyperinflation was followed by a return to robust health (the Weimar hyperinflation, the end of Polish communism). In others, political upheaval followed hyperinflation, but these upheavals seem to have been related to wars or civil unrest (which in turn probably caused the hyperinflations). So I'm not denying the possibility that Japanese "reflation" could cause Japanese civilization to collapse; I'm merely saying it would be something new and unprecedented if it did.

3. Ikeda mentions the long stagnations that followed the Japanese "bubble burst" of 1990 and the American financial crisis of 2008. But it is important to remember that these involved deflation, not hyperinflation. The two are not the same; in fact, in one important way they are opposites. Deflation exacerbates debt; inflation destroys debt. A Japanese hyperinflation (or sovereign default) would eliminate Japan's government and corporate debt. That would act as a tax on the old people who own bonds. But it would remove the overhang of debt from Japan's economy, increasing the expected future income of workers and young people. That might be good for Japan's economy, not bad.

So it seems to me that the main risk of a Japanese hyperinflation is political. If hyperinflation caused a revolution and a collapse of the current regime, a much less effective Japanese regime (yes, you read that right!) might replace it; perhaps an autocracy. That, I agree, is a big risk.

So I'm left ambivalent about "reflation". I still think it's worth a try. I think hyperinflation seems unlikely (though I don't really know this for sure). Based on the historical evidence, I don't think the economic risks of hyperinflation are particularly huge. But the political risks might be big. And that might be reason enough to avoid "reflation". I can't say for certain, though I still definitely lean toward reflation.

In any case, as I said, Shinzo Abe is unlikely to actually carry through any sort of serious push for reflation. So the question is, in all likelihood, a moot one...


  1. Ben Johannson1:37 PM

    Nations affected by hyperinflation share certain characteristics: devastating war, massive loss of productivity, collapse of the tax base, owing debts in a foreign currency.

    There's a tendency among hyperventilators to assume hyperinflation is simply really bad monetary inflation and is therefore always a real danger, so they've been screaming for five years now about deficits and QE (nevermind they're always wrong about it).

    A monetary push to inflate is not going to be successful because piling up reserves and making loans less expensive is deflationary. By driving down rates, interest income to the private sector is reduced, just as the Fed took almost a hundred billion dollars in "profits" which would otherwise have gone to the private sector this year. The way to encourage inflation is to raise interest rates and stop removing interest-bearing financial assets from private hands.

    More monetary stimulus will just step harder on the brakes.

  2. Reflate, inflate or bust, all the same.

  3. The Japanese unemployment rate is apparently 4.1%. There may be little that can be done through monetary easing that would make much difference. My understanding is that one of the things holding the Japanese economy back is that the domestic economy is heavily regulated. De-regulating the domestic economy might be a way to bring some dynamism to the economy (but at the potential cost of increased unemployment).

    1. Once again, Absalon and I are in complete agreement...Absalon, you hereby win "commenter of the month"...

    2. I'm a complete amateur and find the discussion thought-provoking.

      If the unemployment rate is so low, wouldn't talking down the Yen be inflationary as the export sector picks up and looks to hire more workers? Or would they just add more robots?

    3. Ben Johannson2:27 PM


      Full employment can only generate inflation if it pushes demand beyond the economy's productive capacity. So if, for example, the additional incomes of that previously unemployed 4.1% resulted in greater spending than what is necessary to purchase all goods and services available domestically and via imports, you'd see monetary inflation (too much cash chasing too few real resources).

      I simply do not see that happening given:

      A) the persistence of deflation despite a relatively low unemployment rate.
      B) The strong tendency of Japanese to save (the definition of which is income not spent).

  4. Absolon: the Japanese have their own type of wage rigidity, so disregard this fact.

    I say load up the helicopters AND fiscally stimulate the crap out of those islands.

  5. Anonymous8:06 PM

    Yeah, the Japanese should be sick of wasting time by not invading China.

    Really, what is the probability of that happening?

  6. I really wish that the anti-inflation people would acknowledge and address the fact that there is a *huge* difference between hyperinflation, on the one hand, and higher-than-normal inflation such as the US and many places experienced in the 70s, or that some Latin American countries tolerate. Not even the same ballpark. And although I share your skepticism about the central bank's power -- at least as long as it refrains from radical moves like literal helicopter drops -- I'd propose that 10 percent inflation is not nearly as bad as we've been taught to think.

  7. @Will: Right. How about 3 or 4%? Bernanke is apparently terrified that anything above 2.5% risks a dreaded wage-price spiral, or other effects that would overwhelm that positive impacts on *real* growth. Is there any historical evidentiary basis for this concern? Beyond anecdote?

  8. A Sinclair12:37 PM

    Debt is the problem as you have bond markets that are huge. The Central bank can print and buy bonds but that will collapse the currency and the main holders of the bonds will then sell their bonds and the bond market will then collapse. Current interest on the national debt at less than 1% absorbs 23% of total government revenue. Inflation is not an option for Japan. Insurance companies, Japan Post Holdings, GPIF, the retirement fund ($1.4 trillion) are the major holders of JGB's. Japan Post Holdings ($3.8 trillion), the largest financial institution in the world and GPIF ($1.4 trillion) hold above 70% of total assets in JGB's. As a point of reference, total U S bank deposits are less than $10 trillion. Could you imagine one bank holding 40% of total U S deposits? Basically this means that the Japanese people have saved tons of money and loaned it to their government which has wasted it trying to stimulate the economy. The people took few risks and placed their savings in what is normally considered very conservative places; they will lose most of their wealth. Current government budget deficits (about 60% of current spending) must be eliminated. The current path will result in bankruptcy. Losses on bonds would do untold harm to social security, retirement funds, banks, insurance companies. Sustained 2% inflation would destroy government finances. Deflation is not the problem; it is an economy that has too many rules, regulations, too big a government. It is not currently competitive and needs to get government out of the way. The government has wasted the resources of a very conservative people.

  9. Anonymous12:49 PM

    I agree, somewhat, with the snark. Only in Japan could an autocracy be less effective.

    But the ineffectiveness of the Toyoda Bakufu should be expected to be short-lived. It would only be a result of the typical plodding and conservative response to crises from Toyoda-jo. In the end, however, Japan will be much better off; especially at a 140-yen dollar. After all, what's good for Toyota...

  10. No, Japan should not reflate. Too many things are going on for any targeting aimed at an average to be successful.
    There is, perhaps, since I haven't looked at any of the statistics, a very similar situation to what happened in AmerChiEur in 2008, except completely different.

    So, in our case, we have a chain of illogically supported derivatives, "suddenly" subjected to fiduciary reckoning. This continues, bouncing round the world, and will not be settled soon, but is less panicked. People are slowly doing their homework, and lots still coming up with the wrong answers, But, there it is.

    In their case, banking concentration was never reduced [?] after the housing bubble mop-up and 1997. So, with interest rates so low, a slodge of derivatives could be spawned, perhaps [?] equal in volume to the AmEurChins, but more or less OK fiduciarily.

    Hence, while in our case the mopping up had to be done by the Fed on the open market, but in the Japanese case, the mopping up will have to be done "internally"within the congeries of central and associated large stock banks.

    The Japanese C.B. will have to "suck it up," out of the system, but with a different tactic. Different from the BOE in the '00s of the 19th, [read Goodhart's book on J.S.bnkg] and from ours. The national bonds aren't problematic now because they are _sound_ like the consols and monte vecchio were for a while. Every time is different, but we have always done it with interest rates. This time _is_ different, perhaps for the first time or others know others, the Japanese central bank should engage in the Giro function it was intended for. Offsetting the excess liabilities of one group with the excess assets of others.

    What's it going to cost them, 0.0101 percent? You see, for all of that effort, the Japanese _have_ managed to at last find the fundamental long-term interest rate, until the climate mess has been resolved.

  11. "...The only risk, on the other hand, is hyperinflation. How much should we fear hyperinflation? In terms of its effect on the economy..."

    Typically something else has to happen before going into hyperinflation. That thing is known as "inflation". As measured by the GDP implicit price deflator, Japan has been in deflation since 1994, or for 18 years.

    Steve Hanke wrote an excellent working paper this year on hyperinflation:

    He compiles a list of 56 episodes of hyperinflation since 1795. Here is what he says about the definition of hyperinflation:

    "The literature on hyperinflation is riddled with a variety of definitions, and more often than not, they are vague and ill-defined. In search of a cornerstone for our definition of hyperinflation, we began with Philip Cagan’s (1956) widely accepted definition: a price-level increase of at least 50% per month.

    Under Cagan’s definition, an episode of hyperinflation starts when there is a month in which the price level increases by at least 50%. When the monthly inflation rate drops below 50% and stays there for at least one year, the episode is said to end. However, even Cagan does not strictly adhere to his own definition. For example, in addition to making several errors in his hyperinflation table (1956: 26), Cagan selectively excludes Germany’s 1920 case of hyperinflation, presumably because of its short duration (one month)."

    To see how inflation has to precede hyperinflation let's take a look at Weimar Germany more closely. The German wholesale price index can be found on Table V, page 442:

    World War I started in July 1914. By August prices started rising. Inflation reached double digit levels almost immediately with annual inflation in 1915 being 34.7%. But thereafter prices rose more slowly averaging 19.8% a year over the four years through 1918.

    With war's end inflation took off reaching 92.2% in 1919, 257.4% in 1920, falling to 28.8% in 1921, then rising to 1685.6% in 1922 and going into sustained hyperinflation (50% a month) in May 1923. (Note that in terms of wholesale prices there is no evidence of hyperinflation in 1920.)

    So from the time that Germany suffered a rate of inflation faster than at anytime in American history, it took 8 years involving defeat in a devastating war before sustained hyperinflation set in.

    Now, there are cases of hyperinflation setting in almost immediately following the demise of a currency area, such as the end of Yugoslavia and the Soviet Union in the early 1990s. But in every case involving a country with its own currency from the beginning, hyperinflation was preceded by years, sometimes decades, of double digit inflation.

    For example China had suffered double digit inflation since 1937 when it went into hyperinflation in 1947. Brazil had consistently experienced double digit inflation since 1967 when it went into hyperinflation in 1989. Zimbabwe had been in double digit inflation since 1989 when it went into hyperinflation in 2007. (And so on, and so forth.)

    So before we start talking about the risk of hyperinflation, perhaps we should discuss the risk of inflation, which in Japan's case is something they haven't experienced in nearly a generation, and clearly would be a good thing.

    1. And why should rampant inflation worry Japan?

      Are you saying for fear of going off the cliff, you will not walk close to take in the view? Or perhaps the camera is filled with fast B&W.

      Get color! Why should prices move at all? You can do a lot with cheap things, if they are at a natural level relative to the world as a whole!

    2. My advice is to stay away from the brown acid.

    3. Sorry, I am trying to make a serious point. Please read the Stern Report, Chapter 2. He has a different number than mine, but also around 1%. I would like to stay away from the brown acid, but it is in the air.

      Meanwhile - what I am talking about is simply balancing the books across companies, internally, via the Giro bank. That would make much more sense than driving an inflationary process through the economy. I do understand that it sounds strange; but what if I make a loan to you and you to he and he to me etc., so what? Well,each of us takes a markup; and we end up with clogged investments with altogether too many parties involved in each activity. Those loans are also derivatives, aka real options. This is not just a problem with Japan; but supposedly, according to what we were taught at University, Japan Co. is very interlocked. Is that an advantage, still?

    4. "Sorry, I am trying to make a serious point."

      Well evidently you have to try a lot harder. This post is about *Japanese monetary policy*.

      You're yammering on and on about global climactic change and "Giro banks" (whatever the heck that is). It's your job to make those things relevant, and so far, in my opinion, you've done an exceptionally poor job of it.

      Take off the tin foil hat and come down to planet earth.

    5. That's pretty funny. Perhaps you didn't read my post above yours. In my opinion, we are both talking past Japanese reality; and you are suggesting Japanese society is the same as ours, while I am suggesting they are different. Neither of us has made any claim of relevant expertise; and I hope someone who knows something about the case at hand or whose blog this is will weigh in.

      Ex parte though, you are not helping whatever point you are trying to make by denying climate change, or that Stern review's Chapter 2 advocates an effective discount rate of around 1.0%. Japan's 12 month JIBOR, 12/31/12, at 0.48714 % is low enough to contemplate an administered squeeze on spread without greatly threatening long-term discount logic.

      Relax. There is an old saying that when one points the finger, three fingers are pointed at oneself. Economics is hard enough without that.

      enough said, really.

    6. 1) "Perhaps you didn't read my post above yours."

      No, I did. In my opinion it's jargon without a purpose. Life's too short for me to waste my precious time trying to translate jargon.

      2) "In my opinion, we are both talking past Japanese reality; and you are suggesting Japanese society is the same as ours, while I am suggesting they are different."

      Monetary economics is the same everywhere.

      3) "Neither of us has made any claim of relevant expertise; and I hope someone who knows something about the case at hand or whose blog this is will weigh in."

      I'm an applied macroeconomist.

      4) "Ex parte though, you are not helping whatever point you are trying to make by denying climate change, or that Stern review's Chapter 2 advocates an effective discount rate of around 1.0%. Japan's 12 month JIBOR, 12/31/12, at 0.48714 % is low enough to contemplate an administered squeeze on spread without greatly threatening long-term discount logic."

      I never denied global climactic change or the need to mitigate it. The effective discount rate referred to in the Stern Review is used for discounting the costs and benefits of mitigating global climactic change. The question remains, what on earth does this have to do with monetary policy?

      5) ""

      Yes, I googled it when I read your original comment. I still totally fail to see its relevance to monetary policy.

      6) "Relax."

      I am. My point is if you are trying to make a serious point, you are failing miserably. And as long your expectations are that low, then everything is dandy.

    7. Thanks,
      Finally we can get somewhere. I'm now on applied nutritional economics, working with data on Brazil (the POF) that allows me to sum to its macroeconomy. I got into this from the macro direction, looking for variables to add to country risk measures. I also spent a few years in menial but informative jobs on Wall St., so probably know what's.

      If you have read Thornton on real bills you know most of what I do, add in Adam Smith of the "Lectures on Justice, Police, Revenue and Arms (.oll, "Jurisprudence"), and just a smidgen of Turgot.

      … “The price of interest may be looked on as a kind of level, under which all labor, culture, industry, or commerce, acts. It is like a sea expanded over a vast country; the tops of the mountains rise above the surface of the water; and form fertile and cultivated islands. If this sea happens to give way, in proportion as it descends sloping ground, then plains and valleys appear, which cover themselves with productions of every kind.” (M. Turgot, Tr. Anon., “Reflections on the Formation and Distribution of Wealth,” 1793, paragraph 90).

      On down to Keynes, who also had procedural knowledge of the city. If you have anything to say on this level, let's hear it.

      The point in 'other' language, is that there are 2 workable central bank models, Bank of Amsterdam, and Bank of England. They fought 4 wars around this, so seriously. The BOA (1609)was more or less a giro bank; and we should be aware quite as successful in 'monetary policy' as the BOE (1694), who preferred to deal in the manner we know of, after washing up in the south seas, by dominating the discount market.

      BOA, once they got over smelling the Tulips, were better at corralling their business establishment, so their market could better fund sovereign debts, pre-eminently, Catherine's.

      Yet, their corporate appurtenances were similar, the VOC, and the East India Co., integrated stock markets, etc.
      And during their simultaneous dominance, BOA and BOE were money issuers. BOA users often deployed theirs as money of account in giro, to get a necessary moiety of the community liquid enough to fund the sovereigns. BOE worked more in the open market. And, the city was useless as a sovereign issuer until after 1794 when the Hopes, Rothschilds, et alia sought refuge in London from Napoleon.

      I'm worried that your, "monetary policy" means Bank Charter Act, so shall stop there. The 1844 act, was completely ignored by the BOE, who continued to manage the market the old-fashoned way, by talking with it.

  12. Bill Ellis6:01 PM

    Even if inflation starts getting out of control , why can't the central bank just call off the experiment by jacking up interest rates until it is choked out like Volker did ?

    Seems to me like Hyperinflation, though a possibility, is not much of a probability.

    1. They could, and from what I gather this is a rather easy thing to do for any modern central bank.

    2. Ben Johannson11:58 AM

      Volker didn't choke out inflation, which at the time resulted from the price of a barrel of oil rising eight-fold in less than a decade. Inflation didn't begin coming down until Carter deregulated the natural gas industry in 1978. Previously natural gas had been capped at such a low price no one could produce it at a profit, but with deregulation the price rose, gas became a visble alternative and utilities switched from oil to gas for electrical generation. Raising rates pumped massive amounts of money into saver's accounts and resulted in worsening inflation as spending went up in response.

      You can see on the EIA's website that oil use took a nose-dive once gas was deregulated, and perfectly coincided with the taming of inflation from 1978-1980.

    3. Ben Johannson2:39 PM

      visble = viable

    4. Bill Ellis6:12 PM

      Inflation was out of control well before the Oil shocks. The oil shocks only exacerbated an already endemic problem.

    5. Therein lies the rub, Japan can't raise interest rates because they will blow up the bond market and cannot raise taxes either as 22% of their population are retired and living on fixed income. I'm a big fan of MMT but that is its great weakness when applied to Japan.