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Tuesday, August 16, 2016

Japan: Can ‘Helicopter-Money’ Inflate Economy?

It is not for a year or two, not even a decade, it is almost for more than two decades that Japan has been suffering from an interminable deflation—after growing at an average of 10% in the 1960s, 5% in the 1970s, and 4% in the 1980s, Japan grew at anaemic rates from 1990s onwards—and no act of its Central bank’s support to inflate the aggregate spending in the country, including massive qualitative and quantitative easing and negative interest rates followed by “Abenomics”, an economic stimulus program launched by the Prime Minister immediately after his taking over the office two years back, could boost domestic consumption and drive away deflation and spur growth.

Of course, Abenomics—an admixture of monetary easing, fiscal pragmatism, and structural reform—initially did impact the market igniting a sharp rally in equities along with a significant depreciation of the yen but it didn’t last long. The yen touching a high of 125 per dollar last year, has again strengthened and the recent Brexit has further strengthened it, and if the current trend is of any indication it may touch 100 by next quarter. Along with yen’s appreciation, equities too have softened while earnings have stagnated. The year-over-year growth in real GDP during the first quarter was a meagre 0.1%, while indications strongly point to a flat growth in the second quarter of 2016. Inflation, the other most important macroeconomic indicator stood below 0% year-on-year during Q1 and Q2, as against the targeted inflation of 2% under Abenomics. To cap it, IMF has reduced its growth forecast for 2016 to an anaemic 0.3%.

Against this backdrop, last week, Prime Minister Abe announced a large spending package of around 28 tn yen to reflate the economy, which is equivalent to 6% of its GDP though he didn’t give details regarding how to fund it. Thus, much against the observation of foreign analysts, who took for granted that Abenomics is dead, the Prime Minister kept it alive as a capable tool to kick-start growth. But the big question is: Can the country afford it, for its public debt is already 250% of GDP? The government however enjoys a unique advantage: since the interest rates are at rock-bottom, its annual interest pay-out is the lowest among the G7 countries.

Nevertheless, this announcement of the PM has raised market expectations high. The Bank of Japan is expected to increase its spending under quantitative and qualitative easing to a tune of 15 to 20 tn yen—almost 4% of GDP. Further, in the light of the recent visit of Ben Bernanke, the former Chairman of Fed Reserve—who in 2002 said, “Under a fiat money system, a government should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is zero...and hence positive inflation”—and his meeting the top leaders of Japan, rumors have crept in about adopting radical measures, including ‘helicopter money’ to reflate the economy.

The hype created around ‘helicopter money’—a kind of Central bank financing fiscal stimulus through money creation—is understandable, for even adoption of unconventional measures such as QQE and negative interest rates, that too, for prolonged periods, coming up short, Japan has perhaps no alternative but to resort to such out-of-the-box approaches. For, such financing is hoped to boost nominal GDP by increasing overall spending on goods and services either by enabling government to increase its own spending or by increasing private sector’s wealth. To accomplish this, the Central bank can print money and transfer it to government account or use it to buy government debt and show it on its balance sheet as an asset involving no earning of interest and no return of the principal, or buy government debt and commit to roll it over perpetually.

Pundits argue that helicopter financing is likely to be more effective because: one, greater public spending emerging from it is sure to increase aggregate demand; two, by supplementing the private sector’s income it would increase wealth more directly than a rise in asset prices as likely to result under QQE; and three, unlike debt financing, monetary financing will not crowd out private investment by pushing up interest rates.

As with every economic theory, here too, we encounter certain disadvantages such as: one, monetary financing that is often undertaken under political influence, erodes the credibility of the central bank; two, it could fuel self-fulfilling expectations for ever-higher inflation; and three, it may make government of the day cast a closed eye on other options such as going for healthy reforms/fiscal adjustments that could pave the way for a healthy growth.

Indeed, Milton Friedman, who first coined this word put a rider over it: “Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” That being the pros and cons of ‘Helicopter money’, one can pretty well understand the unease of Bank of Japan’s Governor, Haruhiko about its adoption.

That said, Japan, the country which is having a unique demographic feature, which invariably influences its overall economic activity, has no alternative but to aim for high and work for its accomplishment through adoption of such out-of-the-box measures.


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