Economics Term Paper

Analysis of Japan’s Economic Recovery
Zhenhao Piao

Section AQ3--10 A.M
TA: Roberta Afonso

Article: New Threat to Japan’s Growth.
Wall Street Journal, November 11, 2013.

1. Introduction
The article points out that Japan’s economy, after three-month consecutive growth, is likely to slow to less than half the pace recorded in the half of the year (Takashi, 2013, para.1). However, the author claims that the slowing pace doesn’t indicate that Prime Minister Shinzo Abe’s economic recovery plan is faltering. Abenomics, master plan of Prime Minister Abe, emphasizes to recover Japan’s economy by depreciating the yen and temporarily increasing infrastructure spending. The author cites the report from International Monetary Fund (IMF) Economic Outlook established in October. The report stated that Japan’s Gross Domestic Product (GDP) would grow 1.2% next year, below the 2% pace for advanced economies. GDP is related to national account, a subject of macroeconomics.
Secondly, the author indicates that the economic growth of Japan affects not only its domestic economy but also the global economy (Takashi, 2013, para.5). Japan, as the world’s third largest economy, has an indispensable impact on global economic recovery. Thirdly, the article analyzes the main issues that cause the slowdown of Japan’s economy such as declining exports, declining consumer spending and central bank’s radical monetary policy. These factors involve macroeconomics aspects such as international trade, aggregate expenditure, and monetary policy, which study and observe the performance, operation and decision-making of an economy as a whole. Moreover, the author states that many of the problems of Japan’s economy originate from emerging markets such as Indonesia and Brazil, which are the destinations for most of Japanese exports. At the end of the article, the author alerts that 70% of newly issued government bonds were absorbed by Bank of Japan, the central bank of Japan.
2. Theory Review and Analysis
Abenomics, economic recovery plan of Prime Minster Abe, involves three main aspects: increasing money supply, increasing government spending, and depreciate the yen in foreign exchange markets. During the first quarter of 2013, Japan’s economy grew 0.9%, the fastest speed since the first quarter of 2012.
First in first, Mr. Abe requests Bank of Japan to issue more banknotes, implement quantitative easing monetary policy and buy newly issued government bonds. Increasing the money supply, in the short run, will cause a rise in price levels—inflation occurs. The equation of exchange states that the quantity of money times the velocity of money equals the quantity of goods and services produced times their prices (Gottheil, 2013, p.246). According to the classical economists, the quantity of services and goods produced depends upon the amount of resources, which will not change in the short term. Furthermore, classical economists believe that the velocity of money always remains constant. Therefore, classical economists emphasize a direct relationship between the money supply and prices. If money supply increases, the price level will absolutely rise because velocity of money and quantity of goods and services remain unchanged. When the Bank of Japan increases money supply by issuing more banknotes, Japanese citizens would naturally expect that there would be a rise in the price levels in the future; therefore, they would open their pocketbooks to consume more goods and services at current market prices. Changes in expectations about future prices will lead to changes in demand. The expectations of inflation in the future drive the current consumer demand to grow. In consequence, the consumer spending is certain to accelerate and lift growth over the next six months (Takashi, 2013, para.11). Secondly, the Bank of Japan has been implemented quantitative easing to stimulate the economy. Quantitative easing is an unconventional monetary policy, by which the central bank buys long-term financial assets from commercial banks and private institutions in order to increase money supply and lower the interest rates. Interest rate is an important factor for producers to determine how much they will spend on investments. Fred Gottheil (2013) indicates that producers are likely to make investments when they believe that the rate of return generated by the investments exceeds the interest rate. In this way, the monetary easing policy will augment the investments. Producers might invest their capitals in replacing obsolete machinery, expand production, construct new facilities for future production and hire more workers. Therefore, more jobs would be created and unemployment would be reduced. According to statistics from Federal Reserve Bank of St. Louis, the unemployment rate of Japan has lowered from 4% in the final quarter of 2012 to 3.7% in the first quarter of 2013. Furthermore, thanks to the substantial economic recovery during the first two quarters in 2013, consumers become more optimistic with their future income. The expectations to future income also increase the current consumer spending. Thirdly, the Abenomics also involves open market operations, the buying and selling of government bonds by the central bank. Prime Minister Abe requests the Bank of Japan to absorb most of the government’s newly issued bonds. By buying government securities, the central bank again increases the money supply. Increasing the money supply could decrease the interest rate and falling interest rates will enhance the quantity demanded of investment. The increase in investment leads to an increase in aggregate demand; thus, the Japan’s real GDP increases. Nevertheless, the author indicates that the Bank of Japan is already buying assets at a furious pace and radical monetary policy may have side effects in the future (Takashi, 2013, para.15). Besides monetary policies, the government also utilizes fiscal policies to prompt economic recovery. According to the article, infrastructure spending likely jumped an annualized 35% on the $104 billion stimulus package passed by the parliament (Takashi, 2013, para.9). Japanese government initiates programs for infrastructure construction; these programs will eventually increase aggregate demands by increasing investment demand. Also, government purchases such as infrastructure spending are among the four expenditure categories. Hence, increased government spending is supposed to lead an increase in real GDP. However, the author mentioned that the government is unlikely to keep spending at the same pace due to the public debt, which is worth over 200% of GDP. Another strategy that Abenomics utilizes is depreciating the yen, Japan’s national currency, in foreign exchange markets. In flexible exchange rate system, the exchange rate is determined by the supplies and demands for a nation’s currency. Since the Japanese government expanded its money supply dramatically, the yen would be depreciated in the foreign exchange market due to the increased money supply. As of May 2013, the depreciation of the yen reached to 102 yen to a dollar, which was around 80 yen per dollar in 2012.
However, the depreciation would benefit Japan’s economic recovery by increasing Japan’s exports. Depreciation refers to a fall in the price of a nation’s currency relative to foreign currencies (Gottheil, 2013, p.416). The national currency becomes cheaper for foreign countries; hence, the national products become cheaper to foreign consumers. More competitive prices drive more demand for Japan’s national goods and services. Therefore, Japan’s exports will increase and lead to an increase in aggregate demand. Exports have been the engine of Japan’s economic growth since 1960. The author points out that one of the new threats to Japan’s economic recovery comes from emerging markets, which are now the destination for most of Japan’s exports (Takashi, 2013, para.7). The slowdown of those economies in emerging markets will reduce the demands for Japan’s exports, slowing down the pace of Japan’s economic growth.
3. Conclusion
In my opinion, the Abenomics has stimulated Japan’s economy for three quarters, the future and sustainability of the radical economic recovery are yet to be observed. Although Japan’s economy relies more on domestic private demand, the economic growth also depends heavily on government expenditure and exports. In order to stimulate consumer spending, investment and exports, the government implemented an aggressive quantitative easing monetary policy and ordered the central bank to issue more banknotes. Due to the increasing money supply, the price levels will definitely rise during the next few months. According to Japan’s government figures, the consumption grew just 0.4% in the July-September period. Therefore, future consumption seems to be even more crucial to Japan’s sustaining economic growth.
Furthermore, as the yen continues to depreciate, it will be more and more costly for Japanese producers and manufacturers to import inputs and capital goods. The production costs of Japanese products will go up and national products will be more expensive for foreign consumers. The rising prices might reduce foreign demands for Japanese exports. Another hidden risk comes from the dramatic increasing government spending, most of which is financed by issuing government bonds and securities. Japan’s government must notice that the public debt is already over 200% of GDP, more than double the US’s debt ratio. High government debt will crowd out private investment. Also, if the government issues more bonds to the market, the price of government bonds will decrease due to the increasing supply. The decrease in the price of bonds might lead an increase in interest rates. Higher interest rates may discourage companies and factories to expand their investment and hire more workers. To sum up, besides the achievements Japan accomplished in the first quarters, the future of Japan’s economic recovery is still unpredictable and to be measured cautiously.
Reference
Abenomics (n.d). Retrieved November 17, 2013 from http://en.wikipedia.org/wiki/Abenomics
Adjusted unemployment rate in Japan (2013). Retrieved November 17, 2013 from, Federal
Reserve Bank of St. Louis Web site: http://research.stlouisfed.org/fred2/series/JPNURAQS Bank of Japan (n.d). Retrieved November 17, 2013 from http://en.wikipedia.org/wiki/Bank_of_Japan
Gottheil, F. (2013). Principles of macroeconomics. Mason, OH: CENGAGE Learning.
Government spending (n.d). Retrieved November 16, 2013, from http://en.wikipedia.org/wiki/Government_spending
Holliday, K. (2011). Japan's economic growth slow down in Q3. Retrieved November 16, 2013 from http://www.cnbc.com/id/101196641
Japan's exports, Retrieved November 12, 2013 from http://www.tradingeconomics.com/japan/exports Nakamichi, T. (2013, November 11). New threat to Japan's growth. The Wall Street
Journal, p.A2.