Thursday, 11 April 2013

Go Abe Go - Proving Paul Krugman Correct

We watch with bated breath for the results Abenomics (the economics strategy of Shinzo Abe the Japanese premier), which is a lethal cocktail of Keynesian supply-side expenditure reckoned to be worth $75bn in this quarter alone and a massive dose of quantitative easing.  Some like Paul Krugman (the liberal conscience of economics) believe it’s the perfect cocktail of goodies to resolve the liquidity trap that the Japanese economy has been in for 15 years or more.  A liquidity trap is where private demand is too weak, so that even at a zero short-term interest rate private consumption (spending by people and private companies) falls well short of what’s required for full employment and positive growth. In these circumstances, monetary stimulus, quantitative easing (QE) is unlikely to have any effect.
Which on is Abe, Angela?
Japan is a very important economy to study and understand as they have been in this liquidity trap for 15 years and these are now the conditions that apply in the US and much of Europe, so if Abenomics works we all need to know how and why.  Krugman argues that people will continue saving even at low interest rates if they believe that central banker are genetically modified to maintain low inflation and interest rates. Krugman is pining his hopes to the idea that Bank of Japan can this time “credibly promise to be irresponsible”.
Read his blog at

I think things are a little bit more mom and apple pie than Krugman.  Private consumption is flat and saving are increasing for two reason, firstly we have an aging population in the west and Japan that are under-funded in their pensions and they are having to stash whatever they can away to cover their endless retirement (same is true with company schemes).  This squeeze on 35-40% of the population is intensified by the terrible savings rates due to all that QE, you need double the pension pot if interest rates are half of what you expected.  Secondly working households are carrying the entire burden of austerity and have no room for manoeuvre, although mortgage rates are down real wage deflation and unemployment have hit them hard. 
So what to do, in the short term I would ignore the saving issue as monetary policy doesn’t seem to have much effect and the medium term expectation is for continued low rates of interest.  I would focus is providing relief to  the working middle class (cutting sales taxe is the most direct route) this would give them money in their pockets, which is likely to flow back into the economy quickly.  This should help prices to rise and eventually force interest rates up.  However unpopular a demand side stimulus is, it's probable to only way to escape the liquidity trap!

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