Monetary policy

This essay will discuss on The Economist (2014). The article spoke about the economic policies Japan implemented, the intention and aftermath of it. It had covered the “three arrows” of which bionics is based upon, namely fiscal stimulus, monetary easing and structural reforms, of which is executed to encourage private investments. Major points from the article will be explored in greater detail and a better comprehension will be derived on how the Japanese government intends to carry the country out of recession and achieve an objection of 2% core inflation rate of which the Bank of Japan (BOG) ad projected.

At the end of this essay, with greater understanding of the purposes and intention of the implemented policies, a conclusion and opinion will be drawn. 2. Monetary easing – Monetary Policy As cited by the Economist (2014), “The scale of the central bank’s action – it will print money to buy 80 trillion yen of government bonds a year. ” Monetary easing as highlighted above by the Japanese government would suggest that they had adopted the expansionary monetary policy via the open market operation tool.

This is further interpreted by Parking (2014: 654) denoting that, The Federal Reserves (Feud’s) attempt to influence the economy by changing the interest rates and the quantity of money is called monetary policy. ” The act of purchasing Japan’s equities on an annual basis is to boost the money supply (MS) in the economy and increase the excess reserves of commercial banks for loans, henceforth addressing the ballooning public debt. Confronted with excess reserves growth, commercial banks would naturally reduce the interest rates for loans.

BOG (2005) states that it promises to sustain a zero rate commitment of which the policy rate will stay at zero until Japan’s economy is out of deflation. This is to encourage borrowing in an attempt to stimulate the economy through expenditure, production and exports. Diagram 2. 1 Japan GAP Growth Rate Chart Diagram 2. 1 depicts Japan is in the midst of a recession. As shown the GAP growth rate remains negative for two consecutive quarters, -1. 9% in the second quarter and -0. 5% in the third quarter of year 2014. This reflects that Japan is experiencing a recovering recessionary economy.

With reference to Parking (2014: 497), “A common definition of recession is a period during which real GAP creases – its growth rate is negative – for at least two successive quarters. ” Diagram 2. 2 Money Market Graph As presented in diagram 2. 2, a boost in money supply would result in a rightward movement of the MS curve, from MIS to MS due to the increase in the quantity of money from IQ to SQ by 80 trillion yen. Even though the nominal interest rate is expected to reduce from RI to RE, but in the situation of the Japan economy where there is a zero rate commitment environment, the nominal interest rate cannot decline any further.

Due to the zero interest rate, spending and borrowings are being stimulated, opposed to encouraging savings. This will result in both household consumption expenditure (C) and planned investment (l) to increase. Based on the subsequent equation stated below, an increase in any component contributes to a higher aggregate demand (AD). AD = C + + G + X- M Diagram 2. 3 AS-AD Model for Expansionary Monetary Policy As illustrated in the aggregate supply- aggregate demand (AS-AD) model above, when the AD curve shifts to the right from DAD to DAD when aggregated demand increases, the price level will increase from Pl to PA.

When this occurs, the real GAP shifts from IQ to QPS, closing up the concessionary gap of Japan’s economy. The Bank of Japan’s decision to print 80 trillion yen to purchase back government bond would result in the depreciation of the value of yen due to the flexible exchange rate. According to Parking (2014: 630), “A flexible exchange rate is an exchange rate that is determined by demand and supply in the foreign exchange market with no direct intervention by the central bank. ” The depreciation of yen is favorable to economic growth as the foreign dollar will be stronger than the yen.

Due to the weaker yen, it will be economical for foreign countries to import Japanese products, leading to an increase in exports. The downside of such an action of a weaker yen would potentially hinder the economic growth, as the cost of imports would proportionally increase. Overall, there will be an increase in real output, employment, consumption as well as investments for Japan. 3. Fiscal Stimulus – Fiscal Policy As mentioned in the Economist (2014), “A rise in the consumption (value-added) tax in April has prompted an alarming drop in spending by consumers. ” and “Having climbed to 1. % in April, core inflation fell to 1% in September”. As such, we can conclude that discretionary fiscal policy was implemented in Japan so as to sustain its credibility. Parking (2014:654) describes fiscal policy “The government’s attempt to influence the economy setting and changing taxes, making transfer payments, and purchasing of goods and services. ” The Japanese government had adopted the increase of consumption tax as a measure of the contraction fiscal policy. Under the circumstance of consumption tax increase, the disposable income (Hyde) of households will naturally decreases and induces a fall in consumption expenditure (C).

In correspond to the same formulae; a reduction in any component will lead to a lower aggregate demand (AD) as well as equilibrium output AD = C + + G + X -M Diagram 3. 1 AS-AD Model for Contraction Fiscal Policy As illustrated in diagram 3. 1 , the AD curve shifts to the left from DAD to DAD when aggregated demand decreases. When the real GAP falls from IQ to QPS, the price level falls from Pl to PA, thus explaining the reduction of core inflation from 1. 5% to 1% as highlighted by The Economist (2014).

Despite the fact that depreciation of the yen being advantageous for economic growth, it does have its drawbacks. As mentioned by The Economist (2014), “A rise in consumption tax, households have had to contend with higher prices for a weaker yen, notably higher energy and fuel costs. ” The depreciation of yen is unfavorable to the consumers as under the situation of having the weaken yen; the outcome is of which the ordinary Japanese will find their cost of living to be costly. To allow the ordinary Japanese to become accustom to the increase in consumption tax and return to normal consumption expenditure, Mr..

Abe made a strategic decision in laying the next rise of consumption tax, from 8 to 10% to 2017. (Jonathan Another, Business Vancouver, 2014) 4. Structural Reforms As quoted by the Economist (2014), “Such as allowing firms to fire permanent workers in return for severance pay while also making the employment of millions of workers on non-permanent contracts more secure” Through enforcing such drastic measures, it expedites the formation of a flexible labor market, which eventually facilitate to a lower unemployment rate and a higher GAP.

Diagram 4. 1 reveals that the current unemployment rate in Japan has fallen to 3. 5%. As highlighted by (Alike Sahara and Stanley White, 2014), this unemployment rate would be a 16-year low ever since 1997. Diagram 4. 1 Japan Unemployment Rate Line Graph But strict labor policies have discouraging companies from employing a permanent work force with full benefits in favor contractual work force, which as highlighted by Nathan Another, Business Vancouver, 2014) to be at 35%. As part of Mr..

Babe’s plans for structural reforms, the government, as mentioned by The Economist (2014), has dangled with the idea of replacing permanent employment with a more secure non-permanent contractual employment. With such bold move, companies will be able to conduct cost- cutting measures as it enhances companies’ competitiveness and efficiency in the global economy. With better labor productivity, it will lead to a rise in outputs and exports, which lower the rate of natural unemployment as companies will hire temporary workers to fill up the necessary vacant positions. Mr..

Abe, as highlighted by (Jonathan Another, Business Vancouver, 2014) is looking to create a more flexible labor market which would be against the cultural norm of a “jobs-for-life” decades long practice. The employment of on-permanent employees would provide flexibility and cost control thus, it assists companies to generate substantial profits. Benefits of a flexible labor market can be noted from previous reforms such as the inclusion of women into the labor market. The Economist (2014) features that an approximate of 820,000 women have joined the labor market ever since 2012.

As the changes in the employment-to-population ratio expand, aggregated hours and real GAP will also elevate. As a result, it will aid in overcoming the economic slowdown. With the increase in profits, companies will then be able to give a salary increment, which boosts consumption (C). This is seen in the example of Toyota Motor Corp. as mentioned by (Bloomberg Businesslike 2014) where the union is seeking to raise the base salaries of workers for the first time in five years after the company had reported that profits had quintupled and raising its forecast for the fiscal year to 1. Trillion yen. This would be aligned with Mr.. Babe’s intention of raising base salaries faster than the Increase in cost of living, hence increasing the consumption expenditure and ultimately carry Japan to the projected 2% GAP growth and out of recession. . Conclusion In conclusion, Bionics plan of monetary easing, fiscal stimulus and structural reforms had been implemented to rescue Japan out of deflationary economy. Japan has performed relatively well via the open market operation approach of purchasing bonds.

By printing of money, it devalued Japanese yen henceforth; the consumption expenditure is questionable and unaccountable. The monetary policy has two stages of transmission and is an extended process. As it is contingent on various factors, the response and outcome will be difficult to forecast. However, the zero interest rate ointment environment will encourage consumption expenditure and investments, which will indirectly increase the real GAP and accelerate Japan’s economic recovery. The devaluation of yen increases on exports but risks a high cost of imports.

The initial increase in consumption tax was ineffective as the contraction fiscal policy was detrimental to the recessionary economy. The tax was implemented to address the ballooning public debt and national debt credibility. With the increase of consumption tax, the consumers’ disposal income will be greatly reduced, affecting the rate of consumption and expenditure. By delaying the second increase in consumption tax from 8% to 10% to 2017, it will allow the consumers to accustom to the existing tax and return to normal consumption expenditure.

Even though there has not been much focus on the structural reforms, it has been noted that Mr.. Abe has increased his focus in this area. By looking at the flexible labor market, of which currently accounts for 35% of the work force, it reduced the unemployment rate. By converting the permanent workforce to contractual workforce, the workers received severance pay, which perhaps used to justify the increase in household consumption. A contractual workforce will allow companies to better control their cost and expenditure to yield greater profits of which Mr..

Abe is encouraging these companies to raise workers’ basic wages at rate higher than inflation. In closing, the “three arrows” of bionics of which Mr.. Abe had derived, if it remains on path, will potentially bring Japan out of its recessionary economy. Many factors such as consumption behavior cannot be forecasted and the policies would require to be fine-tuned as they go. With the increase focus on he structural reforms, which may possibly contribute to the increase in wages and expenditure may result cost-push inflation.