Sumner on Abenomics

What markets are telling us about Japan by Scott Sumner

Japan is a perfect case study. Asset markets took off after mid-November 2012, when then candidate Abe first indicated he was going to push for a 2% inflation target. The yen fell from about 80 to the dollar to 103 today, while the Nikkei rose from under 8700 to over 15,300 today. So the asset price gains have been sustained. And we did see a rise in the Japanese price level, RGDP and NGDP. So in one sense Abenomics “worked.” 

On the other hand the Japanese 10 year bond yield is 0.51%, vs. 2.50% in the US, and the 30 year bond yield is 1.67%, vs. 3.30% in the US. That tells me that the bond market probably expects Japanese inflation to remain well below US levels in the long run, perhaps close to zero. And that suggests that Japanese asset markets believe that the political obstacles remain formidable. After all, Abe won’t be the prime minister forever. 

So my overall views on Japan are mixed. I view the depreciation of the yen and the huge stock market rally as signals that the Abe government overcame formidable political odds. Good for them. I view the low bond yields as a sign that the markets now expect the BOJ to rest on its laurels, and not try to push the price level even higher. That’s not so good. The labor market is no longer the biggest problem in Japan; it’s the debt situation. As long as nominal interest rates are near-zero the BOJ is needlessly worsening Japan’s long term fiscal situation. 

Don’t pay any attention to GDP, which soared in Q1 and will plunge in Q2. The forex rate and stock prices are the best short term indicator of how the BOJ is doing. If the yen moves into the 110 to 120 range, that would suggest my political forecast was too pessimistic. If it moves below 95, I was too optimistic. 

PS. Matt Yglesias points out the absurdity of Obama touting the strong jobs market. But Yglesias’s post is marred by an unwillingness to mock Obama for saying this while also arguing for bringing back the emergency unemployment insurance program–intended for lousy job markets.

Andolfatto interviews Woodford

Then Woodford suggests that the relationship between long-term rates and the economy is not as clear as with traditional tools. We agree that it’s not at all clear (never reason from a price change), but we think that’s also true of traditional tools. One cannot assume that lower interest rates produced by the Fed will lead to strong growth in AD. It depends on the relative strength of the liquidity, income and Fisher effects. 

In the final paragraph I quote, Woodford points out that most people think that Fed purchases “obviously” boost the price of the asset being purchased. They misuse the S&D model. Some commenters are outraged that the Fed is helping group X, because group X owns lots of the assets that the Fed is buying. They see dark conspiracies. But the purchase of bonds is also the sale of cash. And more cash boosts inflation, which reduces bond prices. During the 1964-81 period the Fed radically increased the amount of bonds it was buying, this led to rapid growth in the monetary base, higher inflation, and much lower bond prices. So much for Cantillon effects.

Yes, there are cases where large asset purchases are associated with low inflation (such as recently); my point is that there is no consistent relationship between Fed asset purchases and the price of that asset.