Download Accelerating Deflation and Monetary Policy (MAR/03)

Japan Financial Report No.8, March 2003
Japan Center for Economic Research
Accelera ting Defla tion and Monetary Policy
Summary
Deflation is proceeding at an accelerated pace due to the widening deflationary
GDP gap. Eliminating deflation through economic stimulus by increasing the issuance
of government bonds, or an increased amount of buying operations by the Bank of
J a p a n ( B O J ) i s v e r y d i f f i c u l t i n t h i s e c o n o m i c e n v i r o n m e n t . We n e e d t o l o o k a t n e w
and creative measures such as the buying operations of stocks or real estate by BOJ.
F u r t h e r, i f t h i s a l s o f a i l s t o e l i m i n a t e d e f l a t i o n , t h e n w e w i l l n e e d t o c o n s i d e r s o m e
more powerful measures such as levying a tax on cash and deposits (in effect a
negative interest rate policy).
A c c o r d i n g t o J a p a n ’s G D P ( g r o s s d o m e s t i c p r o d u c t ) d e f l a t o r - - a n i n d i c a t o r o f
the price changes in the economy as a whole -- price levels began to decline from
about 1994. It has been close to ten years since then. If we take away the effects of
the hikes in the consumption tax, then the GDP deflator has fallen by a total of about
10% in this time.
In this financial report, we estimate how deflation may accelerate in the future
by finding the function between the GDP gap (difference between actual GDP and
p o t e n t i a l G D P, i f t h e f o r m e r i s l o w e r t h a n t h e o t h e r, t h a n t h e g a p i s d e f l a t i o n a r y ) t h a t
is the cause of deflation, and price changes. Then, we examine the monetary policies
that were implemented after the burst of the economic bubble to find why the easing
of monetary policy by the Bank of Japan (BOJ) has been unable to stem deflation.
Deflationary Gap, Now about 25 trillion yen
We e x a m i n e d t h e r e l a t i o n s h i p b e t w e e n p r i c e c h a n g e s a n d t h e G D P G a p i n t h e
1990s, and we found that even under the same environment of a deflationary gap,
prices were rising in the first half of the 1990s and falling in the second half, and
there was a difference in the acceleration of price changes.
We s e p a r a t e d t h e d a t a i n t o p e r i o d s w h e n p r i c e c h a n g e s w e r e p o s i t i v e a n d w h e n
t h e y w e r e n e g a t i v e t o c o n d u c t o u r e s t i m a t e s . We f o u n d t h a t a l t h o u g h i n b o t h p e r i o d s
the deflationary gap was of the same scale, the price changes in the latter period
accelerated at a rate of about one-fourth that of the first period. This can be
e x p l a i n e d b y t h e f a c t t h a t f o r c o m p a n i e s w i t h e x c e s s l a b o r, i t i s e a s i e r t o l o w e r t h e
rate of wage increase rather than expand the rate of wage decrease.
As we see in Figure 1, after the GDP gap marked the largest level we have
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Japan Financial Report No.8, March 2003
Japan Center for Economic Research
measured here during the bubble period at an inflationary gap of 2.3%, it has been on
a steady declining trend, and it is now at a 7.0 percentage points lower level than the
peak. The size of the deflationary gap is now 4.8% and amounts to 25 trillion yen. In
t h e o r y, i f w e w e r e t o f i l l t h i s g a p f u n d e d b y a t a x c u t , t h e n w e w o u l d n e e d a
permanent tax cut of at least the scale of the gap itself, which is 25 trillion yen. In
the current situation where national tax revenue is only about 42 trillion yen, this
would be impossible.
According to the results of our forecast of price changes, the GDP deflator will
continue to fall with the growing GDP gap. In the October-December quar ter of 2004,
prices will fall over the previous quarter at an annualized rate of 3.5%. This current
deflation is quite severe, and the rate of deflation will continue to accelerate under
current circumstances. Even if the government were able to fill the gap completely
with fiscal spending, this would only result in stopping the rate of acceleration of
deflation, and actually eliminating deflation is extremely difficult.
F i g u re 1 . G D P G a p
4
％
2
GDP Deflator (3 quarter moving average)
→
Forecast
0
-2
-4
GDP Gap
-6
-8
1985
86
87
88
89
90
91
92
93
94
95
96
Calendar Year／Quarter
2
97
98
99
2000 2001 2002 2003 2004
Japan Financial Report No.8, March 2003
Japan Center for Economic Research
M o n e y s u p p l y m e a s u r e s i n e f f e c t i v e d u e t o t h e L i q u i d i t y Tr a p
Since July of 1991, the BOJ has lowered interest rates multiple times,
implemented the zero interest rate policy in 1999, and in 2001 went as far as to adopt
quantitative easing. Due to this quantitative easing measure, private financial
institutions have increased the outstanding balances in current accounts they keep
with the BOJ. This has risen from the 4 trillion yen it had been previously to 20
t r i l l i o n y e n . H o w e v e r, a l t h o u g h t h e m o n e t a r y b a s e ( t h e t o t a l o f c a s h a n d B O J c u r r e n t
account) has greatly increased through quantitative easing, lending has not expanded,
and nominal GDP continues to decline.
In Figure 2, we see the relationship between the monetary base and short-term
i n t e r e s t r a t e s . We o b s e r v e t h a t t h e m o n e t a r y b a s e a s a s h a r e o f n o m i n a l G D P w a s
a b o u t 7 - 9 % b e f o r e t h e z e r o i n t e r e s t r a t e p o l i c y, b u t t h i s h a s g r o w n u n d e r t h e z e r o
interest rate polity and while nominal interest rates have fallen to zero, the ratio has
c o n t i n u e d t o i n c r e a s e a n d i s n o w a b o u t 1 8 % . J a p a n ’s e c o n o m y i s i n a l i q u i d i t y t r a p
whereby even when money supply is increased, it does not lead to declining interest
r a t e s , a n d t h e r e i s l i t t l e e f f e c t o n t h e e c o n o m y. E v e n i f t h e n o m i n a l i n t e r e s t r a t e s a r e
at zero, if nominal GDP continues to decline due to deflation, the bad loan situation
will become worse as the debt burden of companies increase relative to the sales
revenue they earn.
M o r e o v e r, i f s h o r t - t e r m i n t e r e s t r a t e s f a l l t o z e r o , t h e e f f e c t s o f c o n v e n t i o n a l
buying operations of short-term assets will deteriorate. Even if through market
operations, short-term government bonds with zero interest rates are exchanged for
bank notes with zero interest rates, this will not result in any stimulus for the
e c o n o m y. Q u a n t i t a t i v e e a s i n g f r o m i n c r e a s i n g t h e b u y i n g o p e r a t i o n s o f l o n g - t e r m
g o v e r n m e n t b o n d s m a y h a v e l o w e r e d l o n g - t e r m i n t e r e s t r a t e s s l i g h t l y, b u t t h e e f f e c t
of this is almost at its limit.
In order to come up with a countermeasure against deflation, we need to
c o r r e c t l y a s s e s s t h e c u r r e n t e n v i r o n m e n t o f t h e J a p a n e s e e c o n o m y. T h e a u t h o r s
believe that currently the Japanese economy is in a cash, deposit and government
bond bubble. People are selling their real assets in real estate and stocks, and moving
their funds into cash, deposits and government bonds whose values are guaranteed by
t h e g o v e r n m e n t . H o w e v e r, t h e c r e d i t w o r t h i n e s s o f t h e g o v e r n m e n t i n q u e s t i o n i s
declining as the fiscal deficit balloons. Although the government may be heading
towards bankruptcy if the situation is not corrected, people and companies continue
to depend on the creditworthiness of the government. This indeed is a bubble.
The first way of resolving this bubble situation is for the BOJ to supply large
quantities of cash (the subject of speculation), and buy large amounts of stocks and
real estate that ar e currently being s old off. In this serious deflationary environment,
we believe that the BOJ should be conducting buying operations of about 5 trillion
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Japan Financial Report No.8, March 2003
Japan Center for Economic Research
y e n p e r m o n t h i n E x c h a n g e Tr a d e d F u n d s ( E T F s ) , a n d R e a l E s t a t e I n v e s t m e n t Tr u s t s
( R E I Ts ) . I n o n e y e a r, t h e y w o u l d b e b u y i n g t h e e q u i v a l e n t o f o n e q u a r t e r o f t h e
m a r k e t v a l u e o f t h e s t o c k m a r k e t i n c l u d i n g R E I Ts .
B u y i n g o p e r a t i o n s o f t h e B O J t o b u y s t o c k s a n d r e a l e s t a t e w i l l , n a t u r a l l y, p u s h
up the stock and land prices in the short term. An increase in stock and land prices
will improve the balance sheets of corporations and households, and will enhance
t h e i r c o l l a t e r a l f o r l o a n s . M o r e o v e r, i t w i l l m a k e t h e c l e a n i n g u p t h e b a d l o a n s m u c h
e a s i e r. I f t h e p e o p l e c a n r e a l i z e t h e m e a n i n g l e s s n e s s o f c o n t i n u i n g t o d e p e n d o n t h e
credit of the government that continues to have massive budget deficits, the deflation
will end.
H o w e v e r, s o l o n g a s p e o p l e k e e p t h e i r m o n e y i n c a s h , d e p o s i t s a n d g o v e r n m e n t
bonds, a deflationary bubble will begin again. If despite large-scale buying
operations of stocks and real estate after one year do not bring about any results in
eliminating deflation, then the more powerful “negative interest rate policy” is
n e c e s s a r y. B a l a n c e s o f f i n a n c i a l a s s e t s w h o s e p r i n c i p a l s a r e g u a r a n t e e d b y t h e
government such as cash, yen deposits, government bonds, government-backed bonds,
local government bonds, postal savings, and postal life insurance should be taxed at a
rate of the deflation rate plus a margin.
If the government announces that it will tax financial assets and keep their
promise as many times as it takes to end deflation, then assets will be transferred to
stocks, real estate, corporate bonds, loans, foreign currencies and durable goods that
are not taxed. Banks as well will begin to actively lend more as funds that are kept in
current accounts, at the Bank of Japan will be taxed. If funds are taken out of cash
and government bonds and into real assets and goods and services, then the economy
will expand. In order to tax bank notes, they would have to be reprinted and a fee
must be levied to be exchanged. The total taxable amount would exceed 1,500 trillion
yen, comprised of 600 trillion yen in deposits, 240 trillion yen in postal savings, and
120 trillion yen in postal life insurance. For the current situation, where the
deflation rate is over 2%, we would need a tax rate of slightly over this in the 2-3%
r a n g e . Ta x r e v e n u e w o u l d e x c e e d 3 0 t r i l l i o n y e n . S i n c e c a s h w o u l d a l s o b e t a x a b l e ,
there would be no need to freeze deposits.
H o w e v e r, a t a x o n a l l f i n a n c i a l a s s e t s i n c l u d i n g c a s h w o u l d i n v i t e v e r y s t r o n g
resistance from the public. This will not be successfully implemented unless
politicians clearly understand the huge risks associated with letting deflation
continue, and they have the strong leadership to convince the public that this measure
i s n e c e s s a r y.
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Japan Financial Report No.8, March 2003
Japan Center for Economic Research
F i g u re 2 . M o n e t a r y B a s e a n d S h o r t - t e r n I n t e re s t R a t e s
10
9
（lowering of interest rates begins）
91Q3
8
91Q1
Nominal Call Rate (%)
86Q1
7
6
5
4
99Q1
(zero interest rate policy implemented)
3
88Q2
2001Q1
（quantitative easing policy
implemented）
2
95Q4
1
2002Q4
0
0
2
4
6
8
10
12
14
Monetary Base (as a share of nominal GDP,%)
16
18
20
Interest rates rise significantly during period of deflation elimination.
If we can eliminate deflation and the inflation rate rises to 2%, then long-term
interest rates will rise by over 4%. As a result of this, the price of the ten-year
g o v e r n m e n t b o n d w i l l f a l l b y a b o u t 4 0 % . A l s o , t h e g o v e r n m e n t ’s i n t e r e s t e x p e n s e s
w i l l a l s o i n c r e a s e s r a p i d l y. O n c e t h e g o v e r n m e n t r e a l i z e s t h e e l i m i n a t i o n o f d e f l a t i o n ,
then at that stage, they must implement a large-scale tax increase. The Bank of Japan
as well, must get back its base money that has been flooding the market in its selling
operations to prevent inflation from accelerating. The reason for this is, as we saw in
Figure 2, when interest rates are in the 3-5% range, the demand for base money is
about 8% of GDP (about 40 trillion yen).
There is a grave risk that if the Bank of Japan conducts massive buying
operations of government bonds in the 100 trillions of yen, the credit of the BOJ may
be seriously compromised. For example, let us take the case where the Bank of Japan
is to increase its holding of long-term government bonds in the amount of 50% of the
amount outstanding in the market, say about 150 trillion yen. If the long-term
i n t e r e s t r a t e s r i s e b y 5 % , t h e n t h e h o l d i n g s o f t h e B O J ’s g o v e r n m e n t b o n d s w i l l m a r k
a loss of about 60 trillion yen. Thus, even if the BOJ were to sell all of the
government bonds that it bought, it will be unable to collect on the excess current
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Japan Financial Report No.8, March 2003
Japan Center for Economic Research
deposits at the BOJ, and they will be forced to collect them through the issuance of
b i l l s s o l d ( i n t e r e s t b e a r i n g d o c u m e n t s o f o b l i g a t i o n ) ( Ta b l e 1 ) .
Ta b l e 1 .
B a n k o f J a p a n ’s B a l a n c e S h e e t o n a R i s i n g I n t e re s t R a t e
B e f o re i n t e re s t r a t e s r i s e : ( U s i n g a s a t e n d o f J a n u a r y 2 0 0 3 f i g u r e s , i f t h e B O J b u y s
150 trillion yen of long-term government bonds from the market)
Assets
Liabilities
Long-term
government bonds
57 + 150 Bank Notes
70
Short-term
government bonds
26 Current Accounts
20 + 150
Other assets
42 Other liabilities
33
Capital
2
To t a l
2 7 5 To t a l
275
I n t e re s t r a t e s r i s e 5 % . ( A f t e r g o v e r n m e n t b o n d p r i c e s d e c l i n e , B O J a b s o r b s
current account through selling operations)
Assets
Liabilities
Long-term
government bonds
0 Bank Notes
Short-term
0 Current Accounts
government bonds
Other assets
0 Other liabilities
Capital
To t a l
0 To t a l
excess
35
5
14
-54
0
U n i t s : Tr i l l i o n s o f y e n
Source: “Bank of Japan Accounts”, Bank of Japan
If this is the case then the assets of the BOJ will be zero, the liabilities will be
bank bills sold that are interest bearing and bank notes and a deficit will occur on the
interest payments and expenses incurred. The BOJ will then have to depend on the
g o v e r n m e n t t o p r o v i d e t h e m w i t h s u b s i d i e s e v e r y y e a r. C o m p a r e d t o t h i s , i f t h e B O J
conducts buying operations in stocks and real estate, then when the economy is
finally out of deflation, the Bank of Japan will have a huge profit, and the credit of
the BOJ will be enhanced.
So long as elimination deflation results in a higher interest rate, then for both
the BOJ and the government, depending on a further issuance of government bonds
and further buying operations of the BOJ to eliminate deflation is a mistaken policy
to take that will lead to serious problems in the future.
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