Has Japan Turned the Corner? A View from the U.S. Treasury

December 5, 2003


John Taylor, Under Secretary of the Treasury for International Affairs, U.S. Department of the Treasury
John Lipsky, Chief Economist, Global Head of Economic and Policy Research, JP Morgan Chase
John Taylor, U. S. Under Secretary of the Treasury for International Affairs, praised the spirit of cooperation--"especially financial cooperation"--between Japan and the United States. He also noted that the recent positive economic data presages Japan's return to economic health.
Why is he optimistic about the data now, after so many false positives in the past decade? For Dr. Taylor, the most important reason is the change in monetary policy. When the Bank of Japan announced, in March 2001, its intention to increase the money supply until inflation was greater than or equal to 0 percent, Japan's prolonged period of deflation began to be tempered, as the monetary base grew 68 percent, or 22 percent compounded annually. Said Dr. Taylor: "It is still too early to declare victory over deflation, but it's the right direction."
Dr. Taylor is also optimistic about the pace of reform in the banking and corporate sectors. He cited Resona Holdings and Ashikaga Bank as positive examples of effective resolution. He praised the measures put in place to value and capitalize bank loans. "Regulators and auditors will not go easy [on the banks]," he asserted. Moreover, on the corporate side, balance sheets seem better, debt ratios have come down, costs have been cut, margins have improved, and some corporate governance concerns have also improved, he said.
A third reason for Dr. Taylor's optimism is the shift in growth towards the private sector on the macro-economic side. Public sector capital expenditures are negative, in contrast to the stimulant infusion of $1 trillion from 1992 to 2000. Dr. Taylor summarized the lesson learned from Japan's public spending strategy: "It didn't work. This is a problem with old-fashioned Keynesian economics."
Dr. Taylor acknowledged that some structural issues in Japan's economy have yet to be resolved. He said Japan still relies too much on exports for growth, although he noted with satisfaction how deregulation initiatives had taken root in certain sectors, like cell phones and retailing, thus adding to domestic investment and consumption.
He also lamented that deregulation had not necessarily led to a culture of risk taking: "Entrepreneurship statistics are still low. NPLs (non-performing loans) are still a problem. People think [NPL resolution] could be done faster."
Finally, he noted there are still fiscal problems from the era of public spending. Here, Dr. Taylor praised Prime Minister Koizumi for "shepherding" Japan's change in thinking and expressed optimism for the future: "We see a hell of a debate on fiscal policy, pensions and aging; and based on these changes, a fiscal consolidation seems able to be brought about."
What effect do you think stronger growth in Japan will have on the U.S. current account deficit?
Dr. Taylor said it would generate more exports from the U.S. "We have stressed more growth in Japan--and also Europe." This would reduce the U.S. current account, because the imbalance of savings and investment would be redressed "largely through supply side measures," he explained.
Japan has a target for monthly purchases of JGBs [Japanese government bonds[--1.2 trillion--as part of the quantitative easing policy, but it exactly matches the amount maturing. Might it be useful to have a net target?
Yes, because purchases of assets add to liquidity and increases the monetary base, replied Dr. Taylor. Although there are still difficulties getting the base translated into broader aggregate increases, it is still the best focus, he asserted.
Investments in repos--are those effective?
Dr. Taylor said repos were effective as a first step. "Of course, different types of purchases have different types of impact. This is not a one-month operation. The best measure seems to be base."
Why is there so much focus on base money? The base money is up 61 percent, but M3 is up single digits over the same time frame. How can the transfer mechanism be improved?
"It will take time, but base growth will get translated (M2+CD) into higher aggregates... You are seeing deflation turning around, even if you don't think the rates will exceed 0 percent over the next few months." Dr. Taylor said his expectations were validated by the U.S. experience in the 1930s and Sweden's experience in the 1980s.
The Bank of Japan seems to be becoming complacent and to have declared victory too early. Are you concerned?
Dr. Taylor reported good communication with the Bank of Japan and ongoing willingness to stick to their policy. "Markets expect to see 0 percent rates for awhile, even after deflation has substantially gone away," he cautioned.
You praised the handling of Resona and Ashikaga, yet in both cases the Japanese government emphasized that shareholders would be protected.
Dr. Taylor said he had praised the rapidity with which it was being handled rather than the shareholder aspect.
As an economist, do you believe central bank purchases of foreign assets are an effective base money stimulus?
"Yes, it's the sum of assets, not the mixture," Dr. Taylor replied.
Fiscal stimulus didn't work in the U.S. What's your interpretation?
Public works spending is very different from tax reduction regimes; the latter brings more powerful effects, especially if they are permanent, because they create an expectation of a lower tax bill, said Dr. Taylor. He said that he and other economic advisers worked with President Bush during the 2000 campaign on changing the tax rates, especially marginal rates. That marginal tax cut was very timely and made the recession a lot less severe, he asserted.
Is China an economic competitor or an economic opportunity for Japan?
According to Dr. Taylor, growth in China is very important to the world economy; China will ultimately become a bigger importer than U.S. He also noted the importance of Hong Kong and other Southeast Asian economies, which he said were in recovery. What Japan needs, by contrast, is for the domestic market to grow and deepen.
Please comment on the specifics of structural reforms in the agenda for growth that you mentioned.
Dr. Taylor reported that within the G-7, Germany is examining labor market reform in its Agenda 2010; the French are tackling pension reform; the British are focusing on deregulation and encouraging entrepreneurs; and the Italians are concerned with tax rate reduction. "It's an interesting exercise; I see some competition developing between France and Germany, and it's good," he commented.
Can you explain the slowdown of monetary growth in the U.S.?
"I don't have a good explanation," said Dr. Taylor. He noted that the pace of monetary growth is environment-specific: at low rates of inflation, the variability of monetary aggregates to the inflation rate is high, which makes them less reliable--hence the switch to interest rates as a guideline of monetary policy. "The money supply is not as good a measure of monetary stimulus in the short run as it once was."
Dr. Lipsky added that the slowdown in mortgage refinancings was a factor.
--Ann Rutledge


Topics:  Policy

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