Friday, December 11, 2015

For Japan, raising inflation target and increasing wages by 5-10 percent may be better

While some countries are grappling with high inflation, Japan (and in relative terms the developed countries) are struggling with persistent low prices, stagnating wages, low economic growth despite massive monetary stimulus for the last few years, and unemployment. Monetary easing is considered more palatable compared to fiscal stimulus because of the latter's impact on fiscal deficit and public debt. But then when monetary sector has little traction on the real sector during these depressed times (low demand as well as cautious credit flows), the most effective antidote to persistently low prices and growth is fiscal stimulus as the multiplier tends to be higher (in the case of government spending in productivity-enhancing investment projects). So, when GDP grows (faster than fiscal deficit and public debt growth), things may look a little less scary. In some countries this requires policies to deliberately raise inflation, which may eventually stabilize fiscal situation!

Here is a nice piece by Blanchard and Posen of the Peterson Institute for International Economics (PIIE) on what Japan should be doing now to prop up prices and then GDP growth. In a nut shell, Japan may consider raising wages by 5-10% (wage growth has been pretty much insignificant for many years in Japan and it follows the inflation rate).

Excerpts from the article published in FT:

Japan needs inflation, and more inflation than the 0.5 percent achieved with its quantitative easing (QE) program. The need is not for the usual countercyclical reasons, even if the economy is flirting with technical recession. Rather, the country needs meaningful positive inflation for reasons of fiscal stability.
[...]Together, Abenomics and the Bank of Japan's commitment to a 2 percent inflation target were intended to encourage a virtuous cycle from positive inflation to wage increases to greater consumption and so on. The central bank's large-scale asset purchases (Y80 trillion a month of Japanese government bonds) have helped: Inflation has fluctuated between 0.5 and 1.0 percent, an improvement over the deflation of the preceding two decades, and the yen has declined in two stages to Y120-plus to the dollar.
But that decline has proved insufficient to start an inflation cycle in the face of falling energy prices and the recent Chinese slowdown. Nominal wages rose only a little more than 1 percent in 2014 and 2015. For the average Japanese investor and consumer, inflation expectations have not budged.
Japan needs to jump-start a wage-price spiral of the sort feared from the 1970s, but that Abenomics rightly aspired to after 20 years of deflation. Such a cycle should be started by increasing nominal wages by 5 to 10 percent in 2016. Tripartite bargaining is practiced in Japan—i.e., annual nationwide wage negotiations for the unionized part of the Japanese labor force with government participation. A third of the country's workers are covered by these bargains, and many more (including management) have their wage adjustments set accordingly. Even part-time worker pay is correlated with this process. Such bargaining with government input can push wages up, just as in the past it has kept them down. In the 2014 and 2015 wage rounds, the Abe administration publicly advocated a rise in wages but did little else.
[...]The point is not to redistribute income from business to labor. If anything, employers and other price setters should be encouraged to pass on the increased costs from wages to consumer prices and try to maintain their profit margins. The Bank of Japan should maintain QE to accommodate this general price and wage increase until the cycle takes hold over a three-year period. This means replacing the current 2 percent inflation target with something much higher—such as 5 to 10 percent—for several years. This would be unlikely to cause accelerating double-digit inflation, but if it did, the Bank of Japan could easily stop that spiral. In parallel, the central bank should also aim for an exchange rate depreciation proportional to inflation, so as to keep the real exchange rate roughly constant.