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Reload, Reset, or Relaunch? Japan’s Policy Options Luc Everaert Assistant Director Asia and Pacific Department International Monetary Fund September 2016 1 Outline What has Abenomics achieved so far? Why has Abenomics not made more progress? What are the policy options? What are the authorities doing? 2 Abenomics met with some success Reversed undue appreciation of the yen and boosted corporate profits Lifted actual and expected inflation Created modest wage gains and reached full employment Made progress on fiscal consolidation Raised labor force participation and improved corporate governance 1. What has Abenomics achieved so far? 3 But the targets have not been achieved 1. What has Abenomics achieved so far? 4 Current policies will deliver mediocre growth and low inflation Weak growth will persist due to subdued private demand …. Contributions to QoQ Growth (SA) ….and inflation will remain below target Baseline Inflation Outlook (In percent) (YoY; in percent) 3.0 3 2 2.5 1 2.0 0 1.5 -1 -6 Inflation Expectations (y/y) 1/ 0.5 -3 -5 Core (y/y) 1.0 -2 -4 Headline (y/y) Private inventories Private consumption 0.0 Net exports Government spending Private gross fixed investment Real growth (q/q) -0.5 2015Q1 2012Q4 2013Q4 2014Q4 2015Q4 2016Q4 2017Q4 Source: Haver Analytics. 1. What has Abenomics achieved so far? 2016Q1 2017Q1 2018Q1 2019Q1 2020Q1 2020Q4 Source: IMF staff estimates. 1/ Average of one-year ahead expectations from Consensus, market based measures and Tankan Survey of firms until 2016Q2. Projections assume inflation expectations are based on a weighted average of past and future rates of inflation. Jump in 2016Q1-Q2 reflect the effects of the expected consumption tax rate hike in 2017. 5 Public deficits and debt remain high Fiscal deficits are large Putting public debt on an unsustainable trajectory General Government Fiscal Balance Japan: Gross Public Debt1/ and Fiscal Balance (In percent of GDP) 45 45 37.8 32.4 30 34.9 30.7 21.1 30 300 Gross debt (RHS) 2 Fiscal balance (LHS) 0 250 -2 19.8 15 (In percent of GDP) 4 15 -4 -6 Balance Expenditure Total revenue Tax revenue 0 0 200 -8 -10 -12 -15 -15 1990 1995 2000 2005 2010 2015 2021 Sources: IMF WEO database; and IMF staff estimates. 1. What has Abenomics achieved so far? 150 2005 2010 2015 2020 2025 2030 Sources: Cabinet Office; and staff estimates and projections. 1/ Gross debt of the general government including the social security fund. Withdrawal of fiscal stimulus and consumption tax increases to 10 percent in October 2019 are assumed. 6 Headwinds, structural obstacles and limits to policy effectiveness 2. Why has Abenomics not made more progress? 7 Global weakness depressed exports and lowered inflation Global trade slowdown has offset benefits from currency depreciation while…. ..falling commodity prices have failed to boost activity and put downward pressure on inflation Real Exports and REER World Oil Price and Japan Inflation (2012 Oct=100) (In percent; YoY) 120 20 10 110 WEO Oil Price Headline Inflation w/o VAT effect (RHS) 2.0 1.5 0 100 1.0 -10 90 -20 0.5 -30 80 0.0 -40 70 Real exports 60 Jul-10 Jul-11 Jul-12 Source: Haver Analytics. REER Jul-13 -0.5 -50 Jul-14 Jul-15 Jul-16 -60 2012Q1 2013Q2 2014Q3 -1.0 2015Q4 2016Q2 Sources: World Economic Outlook; and IMF Staff Calculations. 2. Why has Abenomics not made more progress? 8 Developments in financial and external conditions complicate the short-term ….and the yen has appreciated strongly since end of 2015 Financial conditions have tightened recently… Japan: Financial Condition Index and Credit Cycle Japan Exchange Rate Movements 130 Yen noncommercial traders' net long-positions (USD bn; RHS) Exchange rate (Yen/Dollar) VIX (1941-43=10; RHS) 50 3 125 40 2 120 6 5 Financial condition index 1/ 4 Credit cycle 2/ Tighter 1 0 115 -1 110 -2 -3 1998Q1 105 2002Q4 2007Q3 2012Q2 2016Q2 Sources: Bank of Japan; Ministry of Finance; Haver Analytics; and IMF staff estimates. 1/ Estimated as the first principal component of (standardized) 3-month TIBOR, 10-year JGB yield, stock price, and NEER. 2/ Estimated as the average of the HP-filtered real total credit growth (deflated by CPI) and total credit-to-GDP ratio. 100 30 20 10 0 95 -10 9/14/2016 8/17/2015 11/5/2015 1/24/2016 4/13/2016 7/2/2016 Sources: Bloomberg, L.P.; and IMF staff calculations. 2. Why has Abenomics not made more progress? 9 Structural impediments are weighing on growth and wages Demographic headwinds are lowering potential growth… Potential Growth (percent) 2 …and labor market duality is preventing wage growth Nonregular Workers and Wage Growth (YoY; in percent) 3 Capital Employment Hours TFP Potential Growth Rate 1.5 Change in full-time wages Composition effect 2 Changes in part-time wages 1 1 Share of nonregular workers (right side) 1/ 35 31 -1 0 29 -2 -0.5 37 33 0 0.5 (In percent of staff) -3 27 2002Q2 2004Q2 2006Q2 2008Q2 2010Q2 2012Q2 2014Q2 2016Q2 -1 2000 2003 2006 2009 2012 2015 2018 2021 2024 2027 2030 Sources: Haver Analytics; and IMF staff estimates. 1/ Yearly Average. 2. Why has Abenomics not made more progress? 10 Profits are accumulating and the labor market is increasingly tight Profits are accumulating in corporate cash holdings And there are more vacancies than job applicants Vacancy Rate and Ratio of Job Openings to Applicants (In percent, ratio) 4 3.5 Vacancy Rate Ratio of Job Job Openings to Applicants (RHS) 3 2.0 1.8 1.6 1.4 2.5 1.2 2 1.0 1.5 0.8 1 0.5 0.6 0.4 0.2 0 0.0 1970Q1 1977Q1 1984Q1 1991Q1 1998Q1 2005Q1 2012Q1 2016Q2 Source: Haver Analytics. 2. Why has Abenomics not made more progress? 11 Aging is dampening inflation and growth Declining neutral rate reduces monetary policy effectiveness Actual Labor Total factor productivity productivity ____________________________________________________ Old age -0.851** -1.157** Dependency (0.338) (0.664) Natural rate of interest Net migration Japan: Natural Rate of Interest (In percent) 4 3.5 3 2.5 2 1.5 1 0.5 0 -0.5 -1 -1.5 1986Q2 1991Q2 Aging reduces productivity growth Lagged Population growth Control variables Lagged dependent Time dummy 1996Q2 2001Q2 2006Q2 2011Q2 2016Q2 Sources: Bank of Japan; Haver Analytics; and Fund staff estimates. Note: The blue line is the actual real discount rate deflated by the inflation expectations estimated from an MA(4) model, and the red line marks the mean posterior estimates of the natural rate of interest from a Bayesian time-varying parameter vector autoregression (TVP-VAR) model following Lubik and Matthes (2015). The shadow areas highlight the recession periods (defined as when the SAAR real GDP growth falls below zero for at least two consecutive quarters). 0.724* (0.361) 2.491*** (0.691) -0.00632 (0.0199) 0.0883** (0.0407) Yes Yes Yes Yes Yes Yes Observations 1380 1380 R squared 0.643 0.585 ____________________________________________________ Robust standard errors in parenthesis *** p<0.01; ** p<0.05; * p<0.10 2. Why has Abenomics not made more progress? 12 Monetary policy has been losing traction Loan growth has stalled, getting little help from NIRP …and markets are no longer impressed FX market reaction on the day of BoJ meetings (Yen/U.S. Dollar exchange rate, percent change) 3.0 2.0 1.0 0.0 -1.0 Appreciation -2.0 -3.0 -4.0 January 29 March 15 April 28 June 15 July 28 Source: Haver 2. Why has Abenomics not made more progress? 13 Fiscal policy is contributing to uncertainty Stop-go nature of fiscal policy contributes to policy uncertainty With adverse effects on investment and consumption 2. Why has Abenomics not made more progress? 14 Japan is at a Fork in the Road 3. What are the policy options? 15 Three alternative policy packages Under current policies all targets remain out of reach within the timeframe set by the authorities Comprehensive policy reload to reach targets under current time-frames Reset of targets and policies to prepare for the long haul Relaunch policies with further unorthodox measures? 3. What are the policy options? 16 Option 1: Reload package Higher incomes and wages with labor contract reform Fiscal and monetary policies for demand support Improved medium-term fiscal and monetary policy frameworks Accelerated structural reforms 3. What are the policy options? 17 Income policies to spur and coordinate wage-price dynamics “Comply or explain” mechanism would help spur private wage growth Wage growth has lagged productivity growth Real wage and productivity growth Different Measures of Earnings (In percent, 1992-2014) (4 quarter MA of total earnings, 2007=100) 1.6 104 1.4 102 Real wage growth 1.2 100 1.0 98 0.8 96 0.6 94 0.4 92 0.2 90 0.0 88 -0.2 0.0 0.5 1.0 1.5 Labor productivity growth Sources: OECD, and IMF staff calculations. 3. What are the policy options? 2.0 86 2007Q1 Total Earnings (per full-time employee) Total Earnings (per half-time employee) Contractual Earnings (per employee) 2009Q1 2011Q1 2013Q1 2015Q1 2016Q2 Sources: Haver and IMF staff calculations 18 Fiscal expansion to close output gap but with preannounced consolidation Mind the rising gap in social security Steady and gradual on the consumption tax Consumption Tax Hike: Deviation in Growth from Baseline (In percentage point) 0.1 Social Security Benefits and Contributions (In percent of GDP) 25 25 20 20 Other Elderly care Health care Pensions Total social security contributions Total social security benefits 0 -0.1 -0.2 15 -0.3 15 -0.4 -0.5 -0.6 -0.7 -0.8 -0.9 (i) 5-stage: 0.5 percent of GDP increase each in year 1-5 (announced in year 1) (ii) 2-stage (pre-announced): 1 percent of GDP increase in year 1 and 1.5 percent of GDP in year 4 (both announced in year 1) (iii) 2-stage (ad hoc): same as in (ii) except that the second tax increase is announced in year 4 year 1 2 3 4 5 6 7 Source: IMF staff estimates. 3. What are the policy options? 8 10 10 5 5 0 0 FY1990 FY1995 FY2000 FY2005 FY2010 FY2013 Sources: National Institute of Population and Social Security Research. 19 Continued monetary accommodation with improvements to the framework Reverse downward drift of inflation expectations Strengthen communication and clarify guidance: Share of households with one year ahead inflation expectation 100 5% ~ 2% ~ 5% 0% ~ 2% 0% -2% ~ 0% -5% ~ -2% ~ -5% 90 80 70 60 50 40 30 20 10 0 Aug-14 Feb-15 Aug-15 Feb-16 Move away from a prespecified time horizon for meeting targets Clarify which inflation measures drive policy Publish a staff baseline forecast together with underlying policy assumptions Discuss alternative scenarios Aug-16 Source: Cabinet Office. 3. What are the policy options? 20 More structural reforms to boost wage pressure and potential growth Restore wage bargaining power Boost labor supply (female, older, foreign) and deregulate Potential Impact of Path-Breaking Structural Reforms (Potential growth; Illustrative) 1.5 10 8 Corporate governance reform (See IMF WPs by Aoyagi and Ganelli, 2014; Galen, 2014) Financial sector reforms that raise risk capital as well as SMEs restructuring (Peterson Institute, 2012) TPP (Peterson Institute, 2012) Product market reform (SEZs, Agricultural, Electricity) 6 Gains from ending deflation 4 Reducing labor duality (See Aoyagi and Ganelli, IMF WP, 2013) Foreign labor (See IMF 2013 Art IV) 0.6 2 Female labor participation (See OECD, 2015 forthcoming) 0.4 0 Potential Impacts (cumulative) 3. What are the policy options? 21 Option 2: Resetting targets and policies 3. What are the policy options? 22 Monetary policy: easy for longer while minding stability risks … with lurking risks to financial stability Limited monetary policy room ... Share of JGB holdings by the Bank of Japan 1/ Inter-dealer Monthly Transaction Volume 1/2/ (In percent) 100 80 70 60 Oct. 2011 Oct. 2012 Oct. 2014 Dec. 2019-QQE 61.1% Dec. 2019-QQE2 50 QQE-2 45.6% 40 QQE 30 22.3% 20 12.1% 10 9.0% 0 600 650 700 750 800 850 Outstanding JGBs 900 950 1000 1050 Note: 1/ Uses deficit projections to forecast outstanding amount of JGBs (size of the bubble). Source: IMF staff calculations. 3. What are the policy options? 90 Monthly transaction volume (In trillion yen, LHS) 80 Turnover ratio (In percent, RHS) 20 18 16 70 14 60 12 50 10 40 8 30 6 20 4 10 2 0 0 Mar-05 Nov-06 Jul-08 Mar-10 Nov-11 Jul-13 Mar-15 Mar-16 Sources: Japan Securities Dealers Association; Ministry of Finance. 1/ Treasury Discount Bills, etc. are excluded from transaction volume. 2/"Turnover ratio" is calculated by dividing the transaction volume by the outstanding amount. 23 Fiscal: steady and gradual consolidation for longer Moving the Philips curve may exhaust fiscal space …and risk fiscal confidence shocks Public Debt Financing in the Baseline CPI all items less food and energy w/o VAT effect ( YoY) Phillips Curve 4 3 2 (In trillion yen; end of period) A: 83Q1-95Q4 B: 96Q1-12Q3 y= 0.3x+2 y=0.1x-0.2 1800 C: 12Q4-16Q2 y=0.2x+0.5 1400 1600 1 0 -1 BOJ-long depository institutions GG overseas financing needs BOJ-short insurance/pension funds others excess reserves at BoJ's CA 1,600 1,400 1200 1,200 1000 1,000 800 800 600 600 400 400 200 200 0 -2 1,800 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 -10 -5 0 Output Gap Sources: Cabinet Office; Bank of Japan; and IMF staff estimates. 3. What are the policy options? 5 Sources: Flow of Funds (BoJ); and IMF staff estimates. Note: Includes both central and local governments' debt (including FLIP bonds). The BoJ is assumed to stop increasing its JGB holdings under QQE2 at end-2017. 24 Option 3: Re-launch unorthodox policies 3. What are the policy options? 25 Risky business: net government debt in different scenarios (percent of GDP) Reload package Krugman fiscal expansion Svensson exchange rate target Turner monetization 3. What are the policy options? 26 Risk-return trade-off remains so far in favor of a comprehensive, balanced package 3. What are the policy options? 27 Where do policies stand? Done To do Incomes policy -Minimum wage increases -Private sector wage hikes -Tax incentives for private through comply/explain and contract -Larger tax incentives (and wage increases reform penalties if needed) -Public sector wage increases -Contract reform Fiscal Policy Near term stimulus -Credible medium-term framework with gradual consumption tax hikes -Independent macroeconomic and budget projections Monetary Policy -Accommodative stance -More sustainable framework -Child and nursing care reform -Corporate governance reform Strengthen communication framework and clarify guidance Structural reforms 4. What are the authorities doing? -Labor supply measures for women, older, and foreigners -Productivity enhancing deregulation -Capital deepening 28 Thank You! 29 References IMF Staff Report for the 2016 Article IV Consultation with Japan: http://www.imf.org/external/pubs/ft/scr/2016/cr16267.pdf Selected Issues (analytical work by the IMF Japan team): http://www.imf.org/external/pubs/cat/longres.aspx?sk=44159.0 “How to Reload Abenomics”, IMF News Article: http://www.imf.org/en/News/Articles/2016/08/02/13/00/NA080216How-to-Reload-Abenomics IMF blog on “Japan: Time to Load a Fourth Arrow-Wage Increases”: https://blog-imfdirect.imf.org/2016/03/13/japan-time-to-load-afourth-arrow-wage-increases/ Davide Porcellachia ”Wage-price dynamics and structural reforms in Japan” WP16/20 http://www.imf.org/external/pubs/cat/longres.aspx?sk=43693.0 George Kopits “The Case for an Independent Fiscal Institution in Japan” WP16/156 http://www.imf.org/external/pubs/cat/longres.aspx?sk=44161.0 Arbatli, Botman et. al. “Reflating Japan: Time to Get Unconventional?” WP16/157 http://www.imf.org/external/pubs/cat/longres.aspx?sk=44162.0 Ikuo Saito “Fading Ricardian Equivalence in Ageing Japan” WP forthcoming 30