New BoJ Governor: Actions Will Speak Louder Than Words


The traditional sport of governor watching will take a new turn this week with Toshihiko Fukui taking over as governor of the Bank of Japan on Thursday. Commentators are already hanging on his every word looking, almost hope against hope, for some sign of change. My own view is we will have to wait: to wait and see what lies behind the words, and to wait and see how events yet to unfold may affect BoJ policy:

Toshihiko Fukui, who takes over as governor of the Bank of Japan on Thursday, signalled that he is prepared to adopt a more aggressive monetary policy, though he said the central bank could not tackle deflation alone.

In confident testimony before parliament on Tuesday Mr Fukui said the BoJ would consider broadening the range of assets it buys, comments taken by analysts to refer to the possible purchase of property-backed securities or exchange-traded funds, a proxy for the stock market.Mr Fukui also said he would look favourably on requests from politicians for the BoJ to raise the Y2,000bn limit on the amount of shares it can buy from commercial banks. The BoJ broke a taboo last September when it said it would purchase shares from banks, but Masaru Hayami, who steps down as governor on Wednesday has been openly nervous about the effect this could have on his institution's credibility.

On the controversial topic of whether the BoJ should set an inflation target, Mr Fukui was less dismissive of the idea than Mr Hayami, though he said it would be foolhardy to set such a target without making clear how it was to be achieved. "I think inflation targeting can be an important policy tool for a central bank," he said. "I still need to debate with the BoJ policy board members whether the conditions are in place for such a policy."
Source: Financial Times
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Why All the Fuss About Deflation

Deflation is a generalised and sustained fall in prices, with the emphasis on generalised and sustained. At any given time, especially in a low-inflation economy like that of our recent times, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.


The above more-or-less is the now commonly accepted definition of deflation. However worrying about deflation is one thing (all thinking economists are now worried about it). Knowing why it is happening, and having something useful to say about what to do about it is another. We can all get interest rates down to the zero limit, and then start dropping our currencies 1930's style - but will it work, or will we only succeed in going round in circles?

Even while there is a growing consensus that the problem of deflation is real, my feeling is we are quite short on analysis. This was also my initial impression when I read the writings of two deflation stalwarts: Paul Krugman and Steven Roach . Importantissimo as their work is in drawing attention to the problem, too much weight in my view has been placed on the debt deflationary dynamics of the burst bubble, and not enough attention has been paid to getting to grips with why this impact has been so deep, and why it is happening now?


Why, for example, is Japan so ill? Certainly we have the boom-bust cycle story (and thanks a lot to Stephen Roach and Larry Summers for this), but are things really so unstable that you cross over a little white line and bingo, you're stuck. This, incidentally, cuts across all those arguments to the effect that we've actually got better at handling economic and financial problems.And why is today's Japan deflation of the chronic, slow-burn variety, which is very different from the dramatic and acute deflation of the 1930's. Again what is the significance for policy of this difference?


My question then is, is there something more important going off? I personally think so: I tend to use the expression 'phase transition' - or regime switch - to describe this move from an inflationary to a deflationary environment, but it's only a metaphor.


So far, I've come up with three candidates:


Firstly the secular decline in the unit price of INFORMATION (ie not just IT equipment, but eg human genome string etc, for more on this see Kurzweil's exponential over exponential, or law of accelerating returns - another thing some people just don't seem to get).


Secondly the changing demography of the developed countries: aging, changing support ratios, changing patterns of saving and consumption etc. Jeffrey Williamson and Angus Deaton, for example, have some interesting material on the growth of the so called Asian tigers that makes very interesting reading here.


Thirdly the changing structure of international production through globalisation, and in particular the entry of China into the WTO. Again Williamson and O'Rourke show how the opening of the New World changed structurally the European economies and facilitated industrial growth. It is only reasonable to expect that the take-off of China and then India will have similarly dramatic consequences in the twenty first century. These three pointers are only a start, my point of departure for an ongoing investigation. I have set up a page on my website and it is my attention to use this page to take this analysis further, and to continue digging until in Wittgenstein's famous phrase, my spade is turned. Anyone else who's interested is welcome to join me there, and mail me if you have anything interesting to contribute.
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Effects of Information Technology and Aging Work Force on Labor Demand and Technological Progress in Japanese Industries: 1980- 1998
Kiyohiko G. Nishimura, Kazunori Minetaki, Masato Shirai, Futoshi Kurokawa

This paper raises many very important issues relating to the continuing economic crisis in Japan. In particular insofar as it relates to questions concerning the impact of new technologies on an ageing society. The report has mixed conclusions. It fails to clearly establish robust relations between IT introduction and productivity. It does however claim that information technology development in the 1990s has had a negative impact on one of the past strengths of the Japanese economy: productivity increases achieved through high-education workers' learning by doing. This result will need further examination, but it does sound a warning, as much for Germany as for Japan. The only serious hope for sustained economic growth in a society with a declining labour force and declining participation rates comes through extracting an increasing productivity component from those who are working. If new technologies, and new forms of work have the consequence of reducing the value to be attributed to experience over initiative and adaptability, then the winds of creative destruction could prove devastating for those societies whose standards of life rest on accumulated stocks of wisdom and expertise.


Abstract: The purpose of this paper is two-fold. First, we examine the direction and the magnitude of substitutability or complementarity between information- and communication-related capital stock and various labor inputs to know about differential impacts of information and com-munication technology on labor demand. In this way, we can obtain information about what segments of workers information and communication technology can effectively substitute for.


Second, we estimate contribution of information and communication-related capital stock and various labor inputs on the value-added growth of the Japanese economy in the recent turbulent era (1980s and 1990s) and explore factors determining technological progress. In particular, we investigate whether rapid accumulation of information-related capital stock has a positive effect on technological progress, examining IT externality. We also discern the effect of compositional changes in labor inputs on technological progress examining the inflexibility issue and IT-induced technological obsolescence issue.


Three remarkable facts emerge from our result with respect to substitutability- complementarity issues. First, IT capital stocks are shown to be significant substitutes for young workers with a low education level, whereas old workers with a low education level are consistently quasi-fixed in all industries under investigation. Second, IT capital stocks have complementary relationship with workers with a high education level in many industries. Third, workers with a high education level and those with a low education level are substitutes. These all suggest that IT investment and human capital accumulation are of utmost importance to overcome possible shortage (in relative terms) of young workers with a low education level caused by rapidly aging population.


As for IT externality, we find at first positive correlation between IT stocks and technological progress in manufacturing, suggesting a strong externality effect of IT capital stocks. In the first glance it is very promising, since this suggests that this IT externality can be used for boosting productivity growth. However, the correlation is not robust. First, if non-manufacturing industries are included, the correlation vanishes. Second, if "Electrical Machinery" is excluded from the sample of manufacturing, the correlation also vanishes. Thus, we fail to discern clear-cut evidence for IT externality. Thus, the proposition that IT "revolution"can pop up productivity growth and can counter the pressure of aging population is not supported by our data, although investment in IT-producing industries is surely an important driving force for economic growth through substitution effects. As for the effect of labor force composition on the rate of technological progress, the results do not support that the "inflexible old worker" hypothesis of productivity slowdown. There is no correlation between the rate of technological progress and the ratio of old workers with low education in the total labor inputs.


However, the results suggest that information technology development in the 1990s has a negative impact on the past strength of the Japanese economy: productivity increase through high-education workers' learning by doing. In manufacturing industries where Japan has been strong, the rate of technological progress in the 1980s has positive (though weak) correlation with "maturing" high-education labor force. That is, the ratio of old well-educated workers in the total labor inputs has a positive (though weak) effect on technological progress. This suggests that the increased average skill among well-educated workers due to longer experience has a positive effect to improve productivity. However, the relationship changes significantly in the 1990s, and we have rather negative relationship. The nature of technological progress apparently changed adversely.
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To Monetise or Not to Monetise, That is not the Question

Curious how almost everyone who's anyone in New York or Washington thinks that the Japanese problem has a monetary solution, while almost everyone who's anyone in Tokyo disagrees. This time it's the turn of Morgan Stanley's Robert Alan Feldman.

Is it too late for Japan? The monetization is now complete along the yield curve. European investors ....worry that Germany might be the next Japan, or that somewhere else might be the next Japan. In particular, criticism has been targeted at the Fed and ECB for not moving aggressively enough in the face of deflation potential. Japan is cited as the example of what not to do, for example, in a paper by the Federal Reserve (�Preventing Deflation: Lessons from Japan�s Experience in the 1990s,� by Ahearne et al., June 2002). Although I agree that Japan has provided some examples of what other countries should not do (just as have European and North American economies at times), the contention that monetary policy was the key failure is, in my view, absurd. Rather, the key omission was an aggressive approach to structural reform in both financial and industrial sectors.

So we get back to the debate on what monetary policy should do. For those who think that ending deflation simply means lowering rates a lot and/or printing a lot of money, Japan�s experience should toll a warning bell. Base money is up by 80% since 1997, while deflation has continued. Even monetarists in Japan now agree that the collapse of money velocity cannot stop without structural reform. Moreover, the Weimar experience suggests that rapid money printing will not end the troubles of the Japanese economy. Even in less dramatic contexts, no one has ever argued that high inflation improves resource allocation -- even if it removes bank debt at the expense of creditors. On the contrary, capital flight is the natural result of such an approach, in the wake of which both confidence and real investment collapse.

I agree with my colleagues that it is necessary for the ECB and the Fed to move aggressively, in order to prevent deflation. Where my approach differs is on the question of whether monetary aggressiveness is sufficient. Easy money was NOT sufficient for Japan to avoid deflation. Structural policies were necessary too. In my view, the real lesson from Japan will be learned only when both Europe and the United States focus on the heavy, political issues of dealing with structural impediments to resource re-allocation in their own economies.
Source: Morgan Stanley Global Economic Forum
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Japan: Let the Fiddler Play On


More on divining the entrails in Japan. Much recent western comment has been mildly optimistic on the possibility of serious change and reform in Japan. Japanese commentators meanwhile, when not actually banging their heads against the wall, seem to spend most of their time tearing their hair out. This piece from the Asahi Shinbun's Senior Staff writer is pretty typical. If they're even halway right it looks like the best we can hope for is more fudge. It seems Duisenberg isn't the only one to be busy fiddling while the empire burns.

British writer Thomas Carlyle, who lived in the same period as Karl Marx, called economics ``dismal science.'' The epithet may well apply to the current economic debate on deflation in Japan. One gets the impression that the nation's economy is going nowhere. The underlying problem seems to be a policy stasis that stems from the inability of policy-makers to draw up a unified blueprint for action. The sense of paralysis was evident at the symposium held last month at the Finance Ministry under the theme: Challenges for Japan's Economy-Deflation and Economic Policy. Symbolic of the policy paralysis is the standoff between the government and the Bank of Japan over ways of beating deflation. Government officials feel this way: ``We are taking steps such as tax cuts. Now it's the BOJ's turn to follow up.'' But central bank officials are deeply suspicious of the government. Their feeling is: ``We could be left holding the bag trying to generate inflation.''The discord came to a head at the symposium, creating acrimony among the participants. Academic panelists demanded that the BOJ change its monetary policy, but some in the audience-politicians and BOJ people-reacted sharply, saying it is wrong to blame only the central bank for inaction. A truce of sorts was called when University of Tokyo professor Hiroshi Yoshikawa, a panelist and a member of the government's Council on Economic and Fiscal Policy, said, ``The important thing is for the government and the Bank of Japan to put together a unified package of measures to remove uncertainties over the future.''

The question is specifically what kind of anti-deflation program should be worked out. If it turns out to be a hodgepodge of halfway measures, the economic situation will become gloomier still. For example, a mere increase in public works investment-a prime example of distorted resources allocation and wasteful spending-would only make things worse. On the other hand, aggressive measures focused on generating inflation could end up creating ``stagflation''-a combination of recession and inflation. What is needed is a bold plan of action-namely, a forward-looking, reform-oriented program to fix deflation. Reform means dismantling the ``construction state''-the bloated system of public works projects-and increasing investment in other areas such as environment, welfare and education. Along these lines, utmost efforts should be made to foster industries of high growth potential and create new jobs.
Source: Asahi Shinbun
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Japan: Which Side Are You ON?


I'm posting this piece from Morgan Stanley's Takehiro Sato since, apart from anything else, it is a hoot. Trying to make sense of what happens in Japan is difficult at the best of times, but when a market oriented party starts to socialise the economy, and the ex-communists begin to demand market based measures, well, I think we move from the world of the sublime to that of the ridiculous. Sato - to steal a phrase from Brad Delong - certainly seems to be 'banging his head against the wall' here. I hope it isn't too painful.

Let�s look at recent remarks by an opposition party official regarding the Industrial Revitalization Corporation of Japan (IRCJ): �The plan put forward by the government calls for dividing bank lending that has concern for recoverability into two categories, with the genuinely bad loan going to the RCC and other watch list loan being handled by the IRCJ. Yet banks should be responsible for the job of lending. In this plan, however, the government-owned corporation will be assuming the responsibility of banks and shouldering the credit risk and then using public capital to cover losses if companies fail, instead of the banks. Rather, banks should be doing the job of industrial revitalization. It does not seem appropriate for such a special public corporation to take on this role.�

Before proceeding, it should be noted that I personally am not a supporter of this party and have no intention of giving it a boost. The party�s core principles call for liberation from the exploitation of capitalism and construction of a planned economy through socializing the means of production. What is stated here, however, is mostly correct regardless of the party�s ideology.

It is rather confusing in Japan that the right-wing �conservative� party is pressing for revision of the national constitution, while the left-wing �reformist� party wants to leave the current constitution intact, for example. We find a similarly ironic contradiction in the party that stands for �liberalism� relying on government control in both macro and micro policy, while the socialist party fights for market principles and resists the takeover of excessively indebted companies by such a government-owned entity. Currently, a conservative to center-right coalition cabinet backs a socialistic economy despite the prime minister�s resolution, while left-wing opposition parties criticize these policies, therefore calling for a market mechanism. Such a distorted situation came to be a normal state of affairs, and the PM has aptly acknowledged that Japan has a socialistic economy along the lines of the former Soviet Union and East Germany.

The IRCJ runs the risk of being transformed into a holding ground for excessively indebted companies and classic example of socialistic policy, if political interference were to be allowed. Likewise, policymakers seek to prevent as much as possible an expansion of social inequalities from a hard-landing scenario. Furthermore, the core capitalistic concept of �profit-making� is seen to be nearly rejected, perhaps from some manifestation of Confucian mentality, which makes the groundwork for oriental ethics.

The most obvious example is banks. There have been policies that effectively reject profit-making by this sector through the Revitalization program which was aimed for the increase of lending to comparatively risky borrowers such as small and medium enterprises. Also, public opinion takes an extremely harsh view of bank profiting. In this sense, I have asserted that Japan�s banking business has been converted into a non-profit organization (NPO).
Source: Morgan Stanley Global Economic Forum
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If there is one thing I have learnt in following the Japanese economy closely over the last couple of years it is that, as far as Japan is concerned, you should take everything with a big pinch of salt. Still, the Nikkei is at a twenty year low, that is real and that is a fact. This week Forbes suggests it could fall below the 8,000 level, and that with year-end book-balancing in sight. They also mention a figure, 7,500, below which the capital adequacy ratios of the Japanese banks would be threatened. I remember it was just six months ago we were talking of going below 10,000 as being critical, but it wasn't. In all of this one thing is clear. The numbers, except for those relating to bad loans and government debt, continue to get smaller. One day a critical point will be reached and we'll have blow out. When exactly that day will finally come neither I nor any other commentator can tell you. The big danger is that the yawn, yawn, plus �a change effect in Japan might mean that when it actually does come we won't be expecting it. In all of this just be sure that, absent a major and unforeseeable change of trajectory, that day will come, and that the consequences for the global economy will be enormous.

Tokyo stocks could plumb new 20-year lows this week as war worries and a host of domestic factors discourage buyers. Analysts said the Nikkei average could drop below 8,000, a key support level, after falling 2.62 percent last week to 8,144.12 -- its lowest close since March 1983. "Investor appetite has dried up, so I won't be surprised if the Nikkei falls below the 8,000 mark," said Reiko Nakayama, head of the investment strategy division at Marusan Securities. Some investors may look for bargains early in the week, but the market's longer-term prospects are clouded by the prospect of a trade-disrupting war on Iraq, worries about North Korea's missile and nuclear programmes, and a weak economic outlook......Analysts said the Nikkei is likely to move between 7,800 and 8,350 this week. The further prices fall, the more Japanese banks and private pension funds are expected to dump shares in the run-up to the end of the fiscal year on March 31.
Nikkei Heading on Down?

With only three weeks to go before year-end book-closings for most Japanese companies, the drop in share prices is bad news for banks, which are saddled with mountains of bad loans, as lower valuations on their stock holdings will erode their capital.

Analysts say many banks' capital adequacy ratios -- a key gauge of financial health -- could fall below the eight percent global requirement if the Nikkei approaches 7,500. At Friday's close, combined unrealised stock losses at the top seven banking groups stood at around 5.84 trillion yen ($50 billion), according to Daiwa Institute of Research. Investors are also concerned about the ability of Prime Minister Junichiro Koizumi to deal with any financial crisis.Friday's arrest of Takanori Sakai, a member of the ruling Liberal Democratic Party, was the latest of a series of political scandals to embarrass reformist Koizumi, whose popularity is fading ahead of nationwide local elections in April. Sakai is alleged to have breached political funding laws.
Source: Forbes
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Down and Down We Go Again


Of course, all this continuing economic uncertainty is doing nothing to revive interest in buying shares in the stock markets. Yesterday it was Japans turn with the Nikkei howevring near two decade lows and the Topix falling straight through.

Tokyo shares fell on Friday morning after a speech by George W. Bush, the US president, increased market nerves, while a report of a probe into alleged stock manipulation by Nikko Salomon Smith Barney hit brokerages.The Topix index fell to a two-decade low on war fears, losing 1.1 per cent to 807.36. The Nikkei average was down 1.2 per cent at 8,269.21. Shares in Sony fell 2.5 per cent to Y4,220 as investors expect the electronics exporter to be one of the front line casualties if war in Iraq leads to a fall in US consumer spending.

The brokerage sector put in the worst performance of the morning after a local newspaper said Nikko Salomon Smith Barney would be investigated by Japan�s securities watchdog on allegations of manipulating stock prices. Shares in Nikko Cordial, which set up the brokerage in a joint venture with Citigroup of the US, fell 9.9 per cent to Y382. Nomura, Japan�s leading brokerage, lost 2.9 per cent to Y1,314. Semiconductor equipment makers were also down after Intel said on Thursday that its revenues in the first quarter could fall 2.7 per cent against the previous year. Advantest lost 3.5 per cent to Y4,960 and Tokyo Electron shed 1. 3 per cent to Y5,230. Hitachi fell 3.7 per cent at Y466 after the company said it may consider selling its headquarters building to a real estate investment trust to help it cut costs.
Source: Financial Times
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Japan: Long Term Yields Continue to Fall


Yes, deflation in Japan is definitely settling down for the long haul. Ten year yields of government bonds hit a historic low of 0.74 per cent today indicating that investors have no belief in recovery any time soon. One passing thought, all the commentaries on Japan make the comparison with 1930s style dramatic deflation. But what we are seeing in Japan, and what we may see elsewhere, is more creeping deflation, hovering in the 1% to 2% range almost indefinately. This seems to me to be knew as a historical phenomenon, and worthy of comment in its own right (an omission which, of course, I will try to correct on another occasion).

Masaru Hayami took the governor's chair at the Bank of Japan's policy board meeting for the final time on Tuesday as government bond yields plunged to record depths, confirming the market does not see an imminent end to deflation.The yield on the 10-year government bond hit a historical low of 0.74 per cent on Tuesday signalling that investors do not expect price rises to erode the value of bond income any time soon.
Source: Financial Times
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