May 28, 2013
"Can Japan Export Its Way to Recovery?"
The new administration of Japanese Prime Minister Shinzo Abe has introduced a three-pronged approach to stimulating growth in Japan. The components of the plan include increased fiscal stimulus through public works, growth strategies aimed at reinforcing private investment, and an aggressive increase in monetary stimulus through unconventional policies.
The third element of Abe’s program has generated substantial controversy in international policy circles. Two measures promoted by Abe’s choice as governor of the Bank of Japan, Haruhiko Kuroda, potentially have major international repercussions.
Kuroda is committed to raising the rate of inflation from zero to 2 percent and driving down longer term interest rates by purchasing government bonds and other assets. Although government officials have stressed they would not directly intervene in foreign exchange markets to weaken the yen, expansionary monetary policy will inevitably lead to considerable depreciation of the yen, which should spur exports and, therefore, increase economic growth.
In this note, we assess the rationale for Kuroda’s aggressive action, the prospects for success along the international dimension, and potential hazards to the Japanese economy.
We use some of the back-of-the-envelope estimates of trade elasticities reported in this post to assess how much of a gain to via trade flows will occur given the yen depreciation to date. Figure 1 shows the Japanese trade balance to GDP ratio.
Figure 1: Japan trade balance to GDP ratio (blue), and ex-fuel imports (red).
With the yen about 20 percent weaker than in the third quarter of 2012, should one expect the Japanese trade balance to improve sufficiently to affect output? Estimates published in 2007 concluded that imports are relatively insensitive to price changes, while each 10 percent change in the inflationadjusted value of the yen induces a 3.4 percent increase in real exports. 2012 estimates suggest the impact is slightly larger, 4.4 percent to 6.1percent. In our own estimates, we find that Japanese exports will increase by about 5 percent in response to such a drop. A sustained 20 percent depreciation, such as that experienced thus far, should result in an increase in real exports equivalent to about 1.3 percent of GDP in the fourth quarter of 2012. This means that after about a year, GDP should be about that much higher. Of course, one can’t simply add the 1.3 percent to the level of Japanese GDP. Although the additional exports suggest a boost to income, the resulting additional income will generate an increased demand for imports, offsetting some of this growth.
Update. Willem Thorbecke has some additional work on the subject of trade flows.
Posted by Menzie Chinn at May 28, 2013 06:40 AMdigg this | reddit
Nice article, Menzie. I was somewhat surprised that the forecast increase in GDP growth based on the recent Yen depreciation is only about 1%, but your arguments make sense.
My issue with the new Abe/Kuroda policy is that if they succeed in getting inflation close to their 2% target, which would be helpful in dealing with their enormous debt, who's going to buy JGBs yielding less than 1%? Even cautious Japanese savers will balk at sustained negative real yields, and their demographic issues will mean fewer savers and more retirees cashing in their bonds to pay their bills. I believe the coming increase in yields despite central bank purchases will hurt the government's budget more than the higher inflation will help. Have you seen any work on this issue?
Posted by: Higher Yield at May 28, 2013 08:29 AM
Why do you expect the increase in GDP to be equal to the increase in exports? In an economy with as much excess capacity as Japan has, shouldn't we think the multiplier will be substantially higher than 1?
Posted by: JW Mason at May 28, 2013 10:45 AM
Japan is TOAST.
Posted by: Anonymous at May 28, 2013 10:53 AM
It's amazing what can be accomplished using slight of hand, the largest transfer of wealth ever in the history of man taking place while the public is kept completely in the dark. Just amazing! :(
Posted by: Chicken at May 28, 2013 10:54 AM
I just heard this morning that Toyota will be moving its Lexus plants to the US because the yen has fallen 20% against the dollar and the BoJ intends to continue pushing it lower. A better header question would be will Japan generate enough exports to offset the loss of corporate production driven out of Japan because of the debasement of the yen?
Posted by: Ricardo at May 28, 2013 10:58 AM
With labor share falling even more in Japan, their monetary policy is inflating the cash reserves of the capital sector. Broad inflation will not catch on unless labor share rises. This would imply that the Yen won't weaken in the long-run and therefore imports won't weaken. The Japanese will try to solve the problem by lowering labor share even more.
"Skeptics note that in Japan, as in other industrial nations, labor's share of national wealth has been steadily declining, and that corporations have usually chosen to use their excess cash assets to expand through overseas M&A."
Posted by: Edward Lambert at May 28, 2013 06:57 PM
"A sustained 20 percent depreciation, such as that experienced thus far, should result in an increase in real exports equivalent to about 1.3 percent of GDP in the fourth quarter of 2012."
JPN exports dropped -0.2% in Q4 2012. What does this say about the model and its support of Kuroda's policy?
Posted by: Ecomedian at May 28, 2013 08:12 PM
Of course, one can’t simply add the 1.3 percent to the level of Japanese GDP. Although the additional exports suggest a boost to income, the resulting additional income will generate an increased demand for imports, offsetting some of this growth.
Another mitigating factor is the extent to which Japanese exports depend on imports due to global supply chain practices. According to the OECD, Japan's domestic value added share of gross exports in 2009 was about 85 percent, which is relatively high, but that share may have declined after the 2011 earthquake due to the need for more offshore outsourcing.
Posted by: BenAround at May 28, 2013 08:21 PM
Higher Yield: What are real yields on US 10 yr Treasurys?
JW Mason: vertical specialization -- imported inputs incorporated in exports -- and marginal propensity to import reduce net increment of autonomous spending; I also assume a relatively low MPC.
Ricardo: These plans to locate production nearer to sales had long been in the works; so it is not because of the yen depreciation but in spite of.^
BenAround: good point; see comment to JW Mason.
Posted by: Menzie Chinn at May 29, 2013 01:49 AM
Ricardo: These plans to locate production nearer to sales had long been in the works; so it is not because of the yen depreciation but in spite of.
I tend to believe what Toyota said was the reason.
The slight recovery in the US is because the dollar has significantly stabilized and so capital from the rest of the world is suddenly chasing the stable currency. Bernenke has said that he will continue existing policies. That could be good news for the US.
But there are headwinds ahead. The recent increase in the FED balance sheet and Professor Hamilton's projection that the balance sheet will expand significantly in the near future could once again begin to debase the dollar. Add this to the massive cost and tax increases coming with Obamacare and a continued recovery looks much less hopeful. 2014 looks to be a bleak year. Get all you can in 2013, like everyone else.
Posted by: Ricardo at May 29, 2013 04:59 AM
Who owns most of the bonds that are 10Y and longer in maturity?
Posted by: Anonymous at May 29, 2013 07:19 AM
Higher Yield: What are real yields on US 10 yr Treasurys?
Based on the Fed's target of 2% inflation and 10-year Treasuries at 2.13%, that would mean a real yield of 0.13%. According to the Philly Fed forecast long-run inflation will be 2.3%, which means a real yield of -0.17%. Alternatively, the 10-year TIPS are yielding -0.14%. So I would say something close to 0%.
I believe Japan's real yields should be higher than in the U.S. since the fiscal situation in the U.S. is much better, and in any case I think nominal yields (and real yields) in the U.S. are headed higher as well.
Posted by: Higher Yield at May 29, 2013 10:41 AM
Inflation is not the answer for a country with a high debt load. A weaker currency increases the cost of imports (energy, food, iron ore, etc.). The net improvement for industry and stocks will have to face the headwinds from a consumer that is stressed with energy and food inflation. Workers that work for international companies will likely see increased bonuses or pay increases but they are a small part of the total. The damage to the average consumer from imports will out weigh the benefits. 2% inflation would move federal interest costs to 3% over time; this would move the total cost of interest from 23% of current revenue to 69% of revenue. That alone is a disaster. They have too much debt to think they can afford inflation. The increase in rates (falling JGB's) is likely to reduce capital in banks and insurance companies by over 20%. Mortgage rates are being raised now in Japan. This plan was not well thought out.
Posted by: A Sinclair at May 29, 2013 01:31 PM