What’s with Japan?

In my previous post, I pointed out that Ben Bernanke’s incoherent testimony on the US economy and Fed policy last Wednesday was followed, perhaps not coincidentally, by a 2% intraday drop in the S&P 500 and by a 7% drop in the Nikkei average. The drop in the Nikkei was also accompanied by a big drop in long-term bond prices, and by a big jump in the yen against all major currencies (almost 2% against the dollar).

For the past six months or so, ever since it became clear that Shinzo Abe and his Liberal Democratic party would, after two decades of deflation, win the December elections on a platform of monetary expansion and a 2% inflation target, the Nikkei average has risen by over 50% while the yen has depreciated by 25% against the dollar. The Japanese stock-market boom also seems to have been accompanied by tangible evidence of increased output, as real Japanese GDP increased at a 3.5% annual rate in the first quarter.

The aggressive program of monetary expansion combined with an increased inflation target has made Japan the poster child for Market Monetarists, so it is not surprising that the tumble in the Nikkei average and in the Japanese long-term bonds were pointed to as warning signs that the incipient boom in the Japanese economy might turn out to be a flop. Scott Sumner and Lars Christensen, among others, effectively demolished some of the nonsensical claims made about the simultaneous drop in the Japanese stock and bond markets, the main point being that rising interest rates in Japan are a sign not of the failure of monetary policy, but its success. By looking at changes in interest rates as if they occurred in vacuum, without any consideration of the underlying forces accounting for those changes – either increased expected inflation or an increased rate of return on investment – critics of monetary expansion stumble into all sorts of fallacies and absurdities.

Nevertheless, neither Scott nor Lars addresses a basic problem: what exactly was happening on Black Thursday in Japan when stock prices fell by 7% while bond prices also fell? If bond prices fell, it could be either because expectations of inflation rose or because real interest rates rose. But why would either of those be associated with falling stock prices? Increased expected inflation would not tend to reduce the value of assets, because the future nominal value of cash flows would increase along with discount rates corresponding to the expected loss in the purchasing power of yen. Now there might be some second-order losses associated with increased expected inflation, but it is hard to imagine that they could come anywhere close to accounting for a 7% drop in stock prices. On the other hand, if the increase in interest rates reflects an increased real rate of return on investment, one would normally assume that the increased rate of return on investment would correspond to increased real future cash flows, so it is also hard to understand why a steep fall in asset values would coincide with a sharp fall in bond prices.

Moreover, the puzzle is made even more perplexing if one considers that the yen was appreciating sharply against the dollar on Black Thursday, reversing the steady depreciation of the previous six months. Now what does it mean for the yen to be appreciating against the dollar? Well, basically it means that expectations of Japanese inflation relative to US inflation were going down not up, so it is hard to see how the drop in bond prices could be attributed to inflation expectations in any event.

But let’s just suppose that the Japanese, having experienced the positive effects of monetary expansion and an increased inflation target over the past six months, woke up on Black Thursday to news of Bernanke’s incoherent testimony to Congress suggesting that the Fed is looking for an excuse to withdraw from its own half-hearted attempts at monetary expansion. And perhaps — just perhaps — the Japanese were afraid that a reduced rate of monetary expansion in the US would make it more difficult for the Japan to continue its own program of monetary expansion, because a reduced rate of US monetary expansion, with no change in the rate of Japanese monetary expansion, would lead to US pressure on Japan to prevent further depreciation of the yen against the dollar, or even pressure to reverse the yen depreciation of the last six months. Well, if that’s the case, I would guess that the Japanese would view their ability to engage in monetary expansion as being constrained by the willingness of the US to tolerate yen depreciation, a willingness that in turn would depend on the stance of US monetary policy.

In short, from the Japanese perspective, the easier US monetary policy is, the more space is available to the Japanese to loosen their monetary policy. Now if you think that this may be a bit far-fetched, you obviously haven’t been reading the Wall Street Journal editorial page, which periodically runs screeds about how easy US monetary policy is forcing other countries to adopt easy monetary policies.

That’s why Bernanke’s incoherent policy statement last Wednesday may have led to an expectation of a yen appreciation against the dollar, and why it also led to an expectation of reduced future Japanese cash flows. Reduced expectations of US monetary expansion and US economic growth imply a reduced demand for Japanese exports. In addition, the expectation of US pressure on Japan to reverse yen depreciation would imply a further contraction of Japanese domestic demand, further reducing expected cash flows and, consequently, Japanese asset prices. But how does this account for the drop in Japanese bond prices? Simple. To force an increase in the value of the yen against the dollar, the Bank of Japan would have to tighten money by raising Japanese interest rates.

PS Lars Christensen kindly informs me that he has a further discussion of Japanese monetary policy and the Nikkei sell-off here.


13 Responses to “What’s with Japan?”

  1. 1 Benjamin Cole May 26, 2013 at 10:26 pm

    Yes, I think Japan investors reacted to Bernanke’s feeble dithering, and are afraid that Bernanke & Co. will quit QE in the face of, say, inflation rising above 1.5 percent.

    After all, the BoJ quit QE back in 2005…and Japan went back into ZLB-recession again…and the Fed has dithered and gone back-and-forth already on QE.

    It is tough, as an investor or citizen, to have faith that the Fed or the BoJ will show resolve in the quest for growth. It is easy to believe the Fed and the BoJ will buckle, and go back to their comfort zones of monetary strangulation.

    OT, but someday I would like you to do a post on the proper accounting treatment of the Fed’s QE holdings. It seism to me there is a major flaw.

    The Fed, having printed (digitized0 cash to buy bonds, now has them on the books. They have been paid for.

    If the Fed sells the bonds for less than it paid, it is supposed to book a loss—and seek mine from the Treasury to make up the difference.

    I am not sure the Fed should ever sell the bonds, but if they did, why book a loss? Why not call the sale a capital gain, and forward the money to the Treasury?

    It seems like an accounting fiction is preventing real stimulus…..


  2. 2 Tas von Gleichen May 27, 2013 at 10:46 am

    I can just see one thing happen in Japan, and that is a monetary disaster just waiting to explode.


  3. 3 Marcus Nunes May 27, 2013 at 11:10 am

    Tans von Gleichen
    “Exploding” is maybe what Japan needs, after more than 20 years “imploding”!


  4. 4 Basil May 27, 2013 at 12:28 pm

    This relates nicely to David Beckworth’s “monetary policy superpower” thesis


  5. 5 Blue Aurora May 30, 2013 at 4:23 am

    Out of curiosity David Glasner, have you heard of the Taiwanese-American economist (and the Chief Economist at Nomura Research and an important advisor to the Japanese government) Richard C. Koo?

    If so, have you read one of these two books by him – Balance Sheet Recession: Japan’s Struggle with Uncharted Economics and its Global Implications, or The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession?



    Richard C. Koo’s intellectual influence has gained ground since the global financial crisis of 2007-2008, and Paul Krugman has named him as the latest incarnation in the “long but thin” intellectual lineage that is the “debt-deflationary tradition” (the other two major figures in that lineage are Irving Fisher, who wrote Booms and Depressions in 1932, and Hyman P. Minsky).

    If you have read either of his books, do you have anything to say in response to Richard C. Koo’s criticisms of the policy prescriptions of traditional monetarism for the Japanese economic situation?


  6. 6 nottrampis May 30, 2013 at 3:32 pm


    i am running out of adjectives for you.

    hopefully your high quality blog is getting more readers from downunder if not I wi lstart the David Glasner fan club!!

    Am I allowed to say I am not a fan of Hawtrey?


  7. 7 David Glasner May 31, 2013 at 1:42 pm

    Benjamin, Well, whatever he did, I would have more confidence if Bernanke could provide explanations that made sense. So far, his track record of making sense is not what I would have expected from a full Professor at Princeton. But maybe I am just a bit too overawed by the Ivy League. About the accounting, I agree the Fed’s responsibility is definitely not to maximize its profits.

    Tas, You’ve been waiting for a long time, haven’t you?

    Basil, Yes a few people have pointed that out.

    Blue Aurora, I have heard of him, but haven’t read his work. The little that I have read about his work by others has not encouraged me to read him, and I don’t have enough knowledge of his writings to even think about responding. I once wrote a post (maybe last fall) which I called “so many QE bashers and so little time” or something like that.

    nottrampis, Well we do live in an age of recycling, don’t we?

    Yes, you are allowed (though not encouraged) to say that. But I had expected more of you.


  8. 8 Blue Aurora June 3, 2013 at 1:21 am

    Regarding Richard C. Koo, David Glasner…what have you heard from his work from other people? I’ve read both of his books, and I think he makes an excellent, modernized argument for debt-deflation somewhat better than Irving Fisher and Hyman Minsky.

    I think that given the scope of his increased intellectual influence, I think it’s time for you to put aside whatever negative impressions you may have gained from secondhand accounts. I’d like to hear your verdict on Richard C. Koo’s work (whether you read Balance Sheet Recession or The Holy Grail of Macroeconomics or both). Perhaps you could respond with a good Market Monetarist critique!


  9. 9 David Glasner June 4, 2013 at 4:48 pm

    Blue Aurora, Sorry, I have no specific recollections about the book. He’s really a just a name to me. You are a tough taskmaster. Whom should I read first Koo or Brady?


  10. 10 Blue Aurora June 4, 2013 at 11:56 pm

    David Glasner: Well either way, it’s going to cost you time. It depends on what you want, and what you task you find more interesting.

    If you want to understand the mathematical aspects of Keynes’s General Theory, then go for Michael Emmett Brady’s articles about that matter published in scholarly journals (see his 1990 and 1994 works in History of Political Economy and his 1994, 1995, and 1996 works in the History of Economics Review). I’ve e-mailed you those articles before.

    If you want to understand Richard C. Koo’s arguments, then go to the nearest university library you can find with copies of either Balance Sheet Recession: Japan’s Struggle with Uncharted Economics and Its Global Implications (Koo, 2003) or The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession (Koo, 2008/2009) available to borrow.

    Fairly or not, Richard C. Koo has more of a reputation in economics circles than Michael Emmett Brady does. So as lame as it is to appeal to authority, and seeing how Brady hasn’t criticized the Market Monetarists publicly at all, reading Koo’s 2003 book or Koo’s 2008/2009 book might be a better use of your time.

    After all, when you’ve read Koo’s work and understood Koo on his own terms, you can then write a response to Koo on this blog of yours. Brady’s articles can be saved for a later time.

    Unless of course, you find it more interesting to do things the other way around – reading Brady’s articles first and commenting on them in a blog-post or in a working paper meant for scholarly publication, then reading one of Koo’s books in the debt-deflationary tradition and commenting on Koo’s arguments on your blog.


  11. 11 David Glasner June 5, 2013 at 8:52 pm

    Blue Aurora, Thanks for the elaboration on the work of Brady and of Koo. I am not averse to reading their work, but there is a lot of stuff out there worth reading. I am not a speed reader, so I have to pick and choose what to read, which means that a lot of what I would like to read never gets read. Let’s see what happens. In the meantime, have you seen Mark Sadowski’s guest post on Marcus Nunes’s blog about Richard Koo’s explanation of the Great Depression. Mark’s discussion is a little too Friedmanite for my taste, but I am more sympathetic to Mark’s view than to Koo’s understanding of what happened in the Great Depression.


  12. 12 Blue Aurora June 5, 2013 at 9:27 pm

    David Glasner: No, I hadn’t, not until you pointed it out to me. And like you, I’m not a speed-reader. That stated, I think you will find reading Koo’s work to be a more pressing priority than reading Brady’s work, as Koo is an adviser to the Japanese government on economic matters. Furthermore, Koo lives in Japan. Evidently, Koo’s work has more relevance to current events going on in Japan.

    That stated, I do agree with you – Mark Sadowski seems a bit too Friedmanite. However, I still would prefer that you read Koo’s arguments for yourself, rather than reading a critique of Koo’s arguments from someone else.

    I do agree with you that monetary policy isn’t completely useless – but I do think that the Fisher-Minsky-Koo debt-deflationary tradition holds some explanatory power that the Market Monetarists so far haven’t properly accounted for with a pressing rebuttal.


  1. 1 A theory is put to the test | Historinhas Trackback on May 27, 2013 at 3:37 am

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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