Marking My Beliefs About Abenomics To Market

by: The Angry Bear

By Robert Waldmann

Via @mattyglesias I learned that David Scutt just reported that "Japan just blew past forecasts for unemployment and household spending." The unemployment rate is 3.3% and there are more vacant jobs than unemployed workers. Overall, Abenomics has worked very well indeed.

I feel obliged to discuss this because I was an extreme skeptic. More exactly, I thought that, after his election in December 2012, Japanese Prime Minister Shinzo Abe would stimulate the economy with even more public spending (ignoring the huge public debt-to-GDP ratio) but his Bank of Japan Presidential appointee Haruhiko Kuroda would not be able to get inflation or expected inflation up to the 2% target using unconventional monetary policy. Then I expected the 3% increase in value added tax (VAT) scheduled for April 2014 to do a lot of damage.

In the event, expected inflation as measured by the nominal interest rate minus the interest rate on inflation indexed bonds increased, actual consumer price inflation increased, and the economy recovered. Then, as widely predicted the VAT increase did a lot of damage, which didn't last long.

After looking at some data, I'm still convinced that I was basically wrong, but not as sure as I was when I gritted my teeth and FREDed.

First, the VAT increase wasn't just a policy mistake - it also creates confusing data. Prices increased almost 3% in the 3 months around the VAT increase as the increase was passed on to consumers. The guess based on simple theory is that 100% would be immediately passed on. In fact, about 90% passed on with some monthly smoothing of prices, including VAT. This is important because indexed bonds are indexed to the consumer price index and so increases in value in Yen when it increases because of VAT.

OK so a glance at some data. Here is the monthly CPI inflation rate (multiplied by 12 to annualize it). The VAT increase spike is very clear. Aside from that nothing much happened. Note Abe was elected December 2012.

I time the VAT spike as ending June 2014, guessing that the huge anualized inflation of May 2014 was a slightly delayed reaction to the VAT increase. From June 2014 through February 2015,* CPI inflation was negative in five months, positive in 3 months and exactly zero in one month. This is not what hitting a 2% inflation target looks like.

Now core inflation (which Noah Smith tells me is called core core inflation in Japan). Monthly inflation was negative in 4 out of 9 months from June 2014 through February 2015. Again, this doesn't look like a successful 2% inflation policy.

Now breakevens. I am very incompetent at finding Japanese breakevens but I did find this which I discuss after the jump (along with quarterly core core inflation which smooths some of the jiggles in monthly inflation).

Japanese breakevens are not taken as seriously as the US and UK breakevens because the market for CPI indexed bonds is very thin and there are very few different CPI indexed bonds. The series shows a break on October 8, 2013 when a new indexed bond was issued.

For what it's worth, the current breakeven rate (now for a bond which will mature in 2023) is about 1%. Again, this doesn't look like a credible 2% target. Also, it was consistently over 0.5% before Abe was elected (I think even before it was clear he was going to win the election).

After Abe's election, there was a marked increase in the breakeven rate of the old bond (maturing June 20, 2018). By June 20, 2013, 0.6% of this should be the expected 3% VAT increase divided by 5 years. About half of the drop in the BEI, which occurred when the new bond was issued, could be dividing that 3% by 10 years (new bond) not 5 years (time till old bond matures). I think it is impossible to tell how much of this was the effect of the new monetary policy and how much the fact that Abe made it clear that he really really was going to raise the VAT.

Finally, quarterly core core CPI inflation. I looked at this because I was worried that the lack of a clear pattern in the monthly data was just due to noise.

This is the quarterly increase in consumer prices, excluding food and energy, multiplied by 4 to annualize it.

Annualized quarter core core inflation is far below the 2% target and didn't increase dramatically following Abe's election. The only dramatic event in the graph is the spike due to the VAT increase.

My conclusion is that I don't know. Can a monetary authority at the zero lower bound, determined to do whatever it takes to cause inflation, actually cause inflation? I had guessed no, then had been convinced I was wrong and the correct answer is yes. Now, I don't know. The Abe Kuroda team does not seem to me to have achieved their stated goal. I suppose one might argue that their determination flagged and that they achieved 2% inflation and 2% expected inflation in 2013, then got distracted. But if Haruhiko Kuroda was not determined enough or Sinzo Abe didn't support him enough, how could we ever hope for a credible commitment to 2% inflation?

*FRED really should update their free data more quickly.