The FT today has an interesting article about the opinions of the IMF delegation which is currently in Japan. These opinions seem to be much more reasoned than much of the current consensus opinion which is emanating from the G7 or the Economist (for example) and especially in connection to the deflation problem and the issues it presents. According to John Lipsky (IMF First Deputy Managing Director) further rate hikes by the Bank of Japan (BOJ) should be delayed until inflation expectations have recovered and the consumer price trend is firmly rising. In particular they take the view that:
"it would be not be appropriate for the central bank to target asset prices, the so-called yen carry trades and currency moves."
I cannot but agree. As the article notes Japan’s core consumer price index, excluding fresh food prices, fell 0.3 percent in March from a year earlier, and while April the figure - due out on tomorrow - is expected to show a lower rate of decline (the March figure is a y-o-y decline of 3.6% rate), prices are still expected to be falling. Any increase in rates which hinders the attempt to move into positive price increase territory (whether by the direct route of raising borrowing costs and hence slowing domestic demand growth, or the indirect one of nudging up the currency) would be extremely unwise, especially given the protracted nature of the deflation phenomenon in Japan.
As Lipsky says:
"The main challenge is to manage a return to a neutral monetary stance in the context of very low inflation"
Perhaps it would be useful to consider just what exactly the three terms - expansionary, neutral, and contractionary - mean in the present Japanese context.
Now as a rule of thumb yardstick we might say a neutral rate is something like 2% above the inflation level (in this sense the current US rate is still a tightening one, since inflation expectations are still thought to be too high). Now in Japan, if the CPI were to be running at around the minus 1% rate, then neutral would be somewhere around the 1% base rate.
The IMF, however, still thinks that inflation expectations are running at too low a level in Japan, it wouldn't be hard to make out a case that what Japan needs - at the very least - is a mildly expantionary rate, which - depending on where the annual CPI actually settles in the short term - the current 0.5% could be considered to be. The "challenge" for Japan, as the IMF notes, is to move above that to the neutral 1% or so (or above, if inflation were to pick up).
This view would, I think, be more-or-less conventional wisdom (rather than G7 or Economist-type hype), but given the difficulties which Japan has been having in breaking the 0% CPI threshold, and given the ongoing weaknesses in domestic consumer demand, and given the fact that in the immediate term one of Japan's most important customers - the US - seems to be slowing I am still far from convinced that the BoJ should have abandoned ZIRP so early in the first place. We will see.
A counter view is expressed by the economists quoted in this Bloomberg article, which describes how yields on Japanese government bonds have been rising slightly in recent days, on the view that any fall in deflation from the March levels will be sufficient ammunition for the BoJ to start thinking about raising rates (and hence the note of concern in the IMF statements).
Typical of this current of thought would seem to be Norihisa Takao, an analyst at Daiwa Asset Management Co. in Tokyo. He cites a recent rebound in the so-called breakeven inflation rate - a measure which represents what the market expects core consumer prices to average in the next decade - as showing that inflation expectations are rising. In some senses this is the exact opposite of the view the IMF seem to be taking, but it is important to note that Takao is talking about long run expectations, while the IMF are focused on the short term expectations issue. The judicious among you may note that the road to longer term inflation passes through (or depends upon) what happens in the shorter term. If short term monetary policy errors push Japan back into some kind of deflation trap, what the inflation rate may or may not be ten years from now is really anyone's guess.
Just how fragile the whole Japanese growth dynamic is at present is revealed by this article which indicates that Japanese exports to the US fell by 4.8% in April, which was the the steepest decline since May 2004. True the drop is still significantly smaller than the 2004 one, but the outlook for the US economy is possibly somewhat more uncertain than it was back then. As Bloomberg notes:
"Auto shipments fell 7.5 percent, the biggest decline since April 2004 when they slid 15.1 percent. Autos represent about 10 percent of Japan's overall shipments to the U.S."
At the present time a good deal of the slack is being taken up by exports to the EU and Asia, but this only takes us back directly to the de-coupling issue, and to just how strong growth in China and Germany (say) would be in the face of a protracted US slowdown. The answer is really that the jury is still out, but there are reasons for thinking that Japan is currently feeling the pinch of the 1st quarter US slowdown via the direct route, but may then feel it via the indirect one if the slower US growth then feeds through to slower growth in Germany and China.
The numbers for machinery orders in Japan in March may give us a first reading here, since they fell by 4.5% over February. Even more worrying is the fact that the expectation is for machine output to fall by 11.8% this quarter. The first indications that the Japanese economy has been slowing of late was , of course, provided by the first quarter GDP number, which came in at an annualised 2.4%, down from the heady annualised rate of 5% in the last quarter of 2006.
True, domestic consumption did do reasonably well in Q1 2007 - rising at an annualised (if still rather meagre) rate of 0.9% (down from the 1.1% annualised rate in Q4 2006), but we would do well to remember that y-o-y, the first quarter number for domestic consumption was still only 0.1% (all these percentages are in estimated real terms), but I suppose you could say that where there is life there is hope.
The big, big, question, is what will happen to domestic consumption during this quarter, if, as seems likely rates of growth in exports slow, and domestic investment declines. According to the sustainable recovery view, domestic consumer demand should now move forward as the second leg of this expansion, something which I think there are good reasons to doubt. Again, as I say above, we will see, but in the meantime I think there are solid grounds for suggesting that the BoJ should pay a good deal more attention to the sound advice they are today being offered from the IMF than they should to the far more optimistic projections being offered by some market analysts.
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