Japanese impressions

I recently spent two intense days in Tokyo, meeting a number of influential observers and policy makers, and I thought the readers of my blog could be interested in the impressions I collected over there. These are the following.

Is there a significant difference of appreciation between the government and the Bank of Japan about the desirable course of the yen?
My interlocutors convinced me that this is not the case. Of course, the Bank of Japan is aware of the help that a weaker yen gave to its attempt to get out of very low inflation, but sees any additional depreciation having more negative than positive effects. It is interesting, in this respect, that the communication of the Bank of Japan has been recently slightly modified: now it is neutral, just saying that yen foreign exchange rates should be consistent with the economic and financial fundamentals and move in a stable manner, while before it said that the weaker yen had pros and cons but the net effect on macro economy was perhaps positive. While exporters consider that they have regained enough competitiveness, importers, in particular the service sector and households, see the additional cost of foreign goods as impacting their purchasing power. For the government, an important, if implicit, additional reason against further yen depreciation is of geopolitical nature. The Abe administration has national safety as its first priority. This means it needs even more commitment from the United States to stand on the side of Japan towards an increasingly assertive China. The successful conclusion of the Trans-Pacific Partnership agreement (TPP) is an essential factor to get the full commitment of the US to the defence of Japan, but further yen weakness would stand in its way. In addition, the TPP is also seen as a way to break domestic resistance to structural measures (e.g in agriculture) that can improve the long-term growth prospect of Japan. The TPP is an important part of Abe-san´s, still weak, third arrow, indeed probably its most important part. The old time ruse of using external constraints to achieve domestic objectives is alive and well also in the land of the rising sun.

Are there signs that the Bank of Japan will eventually succeed in moving Japan away from its long-standing too low inflation?
Private sector economists are split on this issue. On average they expect 0.3% inflation for FY 2015, 1.2% for FY 2016, 1.4% for FY2017-22 (excluding VAT hike). Still, the overall impression I got on this point is that indeed this will be the case. Of course, the time over which the 2.00 per cent inflation rate will be achieved needed to be postponed to the summer/autumn of 2016, but this is regarded as a relatively minor issue, not impacting the credibility of the commitment of the Bank of Japan. Analogously, the 2.00 per cent objective will have to be taken cum grano salis. The arguments I was given to support the relatively favourable assessment are the following:
1. The labour market is very tight, with increasing participation rate and employment;
2. As a consequence of the point above, there are incipient signs of higher wage increases. To get a precise view, one has to go into the entrails of the complex Japanese wage system, consisting of three layers (fixed payment, bonus and special payment), and consider the evolving composition of the labour force (with an increasing number of part time workers). Once this is done, the wage developments are quite higher than the anaemic figure resulting from aggregate numbers.
3. Inflationary expectations have significantly increased.
4. Pricing power is visible in some sectors of the economy, in particular in the consumer goods area.
5. The demand shock coming from the first increase of the consumption tax is out of the way and the government has postponed the second instalment to April 2017.
6. The psychological shock coming from a different attitude of the Bank of Japan (see the following point) is fighting the inertia in inflationary expectations settled during the long period of too low inflation.

The criticism towards the Bank of Japan has changed direction.
The central bank that was in the past often accused of doing too little too late is now seen in some quarters as doing too much, even if no clear alternative to QQE (Qualitative and Quantitative Easing) is being actively discussed. The opposition to QQE does not have in Japan the same fundamentalist roots that opposition to QE has in Germany, but is clearly visible. Some academics fear that instead of just fighting too low inflation, QQE will lead overtime to far too high inflation. Market practitioners, particularly those active in the market for JGBs (Japanese government securities), lament the dominating and distorting effects of the huge purchases by the Bank of Japan. People having a more limited view about the power and responsibility of monetary policy resent the aggressiveness of the Bank of Japan action and consider it unwarranted.
Overall my sense is that a new round of QQE is unlikely, not so much because of the active opposition to it but because even its supporters think that it has reached the point in which its prospective benefits would be more than offset by its drawbacks.

There seems to be insufficient attention in public discussion in Japan to two issues that are, instead, of utmost importance: long term growth prospects and the fiscal situation.
The three points above relate to short-term developments while only few observers ponder over the long-term growth prospects of the Japanese economy as well as its fragile fiscal situation. In this sense the economic policy discussion in the Japanese society seems to be somewhat lopsided, with the cautiously optimistic views on the short horizon prevailing over the more preoccupied one on the long-term prospects. The false dawn of the mid 2000s seems to be have been forgotten in this respect. Connected to this partial perspective is an overemphasis on the mild deflation experienced by Japan as the main cause of the problems of its economy.

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