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Thursday, September 15, 2005

Japan Under The Magnifying Glass

There are a couple of interesting Japan-related articles in the press today. Firstly this one in Bloomberg on rising consumer confidence:

Japanese households became less pessimistic in August for a second month as wages rose and job prospects improved, adding to expectations that consumer spending will spur economic growth. Confidence among households with two or more people rose to 48.4 from 48.1 in July, the Cabinet Office said today in Tokyo.

``As long as the labor market in Japan keeps improving as it's likely to do, confidence should keep strengthening,'' said Glenn Maguire, chief economist for Asia at Societe Generale in Hong Kong.The number of jobs available for every 100 applicants rose to 97 in July, the highest in nearly 13 years, according to the latest figures from the Ministry of Health, Labor and Welfare. Wages had the biggest increase in eight months the same month.

Now this is exactly what theory predicts. As I explain here Japans available workforce is now in decline. The first reaction to this is bound to be a tightening in the labour market (exactly the opposite of the softness in the US one, and incidentally the same kind of demographic explanation is being pointed to in the recent weaker-than-expected UK data). This 'tightening' logically produces a positive sensation among those looking for work: jobs are easier to find, and wages begin to drift upwards.

But this is far from where the story ends, and it would be very short-sighted to imagine this was the case. This tightening will continue and continue. So wages will drift upwards. Again theory predicts that this will then lead to 'capital deepening' as companies find it more and more attractive to replace workers with machines where they can. Again, the initial effect of this deepening may be positive, as it in some ways spurs investment. But obviously all of this puts ongoing pressure on costs, so prices drift upwards. But the ability to pass on prices may be limited so we really don't know how all this will work out in practice.

We also don't know what proportion of the extra wages will be spent, and what proportion will be saved. If the modified life cycle model I refer to in my 'New Economist' post is realistic, then we can expect demand growth to lag significantly behind wage growth. Anyway all of this will be interesting to watch, a real 'learning ezperience'.

The second piece that caught my eye was in today's FT:

The Bank of Japan is “very close” to ending its ultra-loose monetary policy, its deputy governor said yesterday, although he stressed that current policy would be maintained until deflationary expectations were eradicated. Kazumasa Iwata, speaking at a cabinet office conference, said that, by some measures, deflation had already been squeezed out of the economy.“I think we are very close to the exit,” he said, referring to an end of the quantitative easing policy introduced in March 2001 by which the bank floods the market with far more liquidity than is needed to drive overnight rates to zero.

To me this looks a bit like a 'leap in the dark', a keeping faith with your own expectations. Clearly the Japanese economy has been doing relatively better during the last 2 or 3 quarters, but the data are not un-ambiguous, and no-one is sure whether or not this is sustainable (see above) so it seems to me that it is a little premature at this stage to be sounding the all clear, and even more premature for an economist like Kazumasa Iwata, who has previously been arguing that the BoJ should not change policy until price rises stabilised at 1-2 per cent.Why the big rush now to change course?

I found this observation interesting, and also possibly revealing:

Masaaki Kanno, chief economist at J P Morgan, said it was not clear what message Mr Iwata was trying to send. Either he had changed his opinion on the need to keep policy intact until prices rose by more than 1 per cent, or he had altered his view on the progress of actual price changes, he said.

The core CPI, which excludes fresh food, was down 0.2 per cent in July. Japan has been in CPI deflation since 1998. The BoJ has said the CPI is likely to reach equilibrium before the end of the year, as the effect of deregulated prices dropped out of the data.

“Now the BoJ seems to be emphasising that the end of policy could take place in the near term,” said Mr Kanno, setting a less dovish tone than when senior officials were stressing only weeks ago that deflation was “sticky” and not likely to end soon.

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