Japan’s Economic Pitch (Scenario): Continuation of Policy Mix of Aggressive Fiscal Policy and Monetary Easing is the Key to Completely Overcoming Deflation | ZUU online

This article is based on an article in the e-mail magazine distributed on Thursday, October 13, 2022 titled “Okasan Aida, Ta, Matsumoto Ken Underslow (A New View of the Japanese Economy), Pitch for the Japanese Economy (Scenario): Aggressive Fiscal Policy and Monetary Easing” Continuation of the policy mix is ​​the key to completely overcoming deflation”.

Main Scenario for Japan: Continuation of Policy Mix of Aggressive Fiscal Policy and Monetary Easing

1.As the Kishida Cabinet continues to expand its fiscal policy through both its distribution policy and growth investment, the net demand for funds (fiscal balance + corporate savings rate) will recover, creating a macro structure in which income goes to households, and a new capitalism will begin to operate.

2.With the continuation of tenacious monetary easing by the Bank of Japan, a strong credit cycle will be maintained despite the slowdown in external demand in FY2023.

3.With the yen depreciating, the government’s growth investment centered on green, digital, advanced science and technology, and economic security has stimulated growth, and the recovery in domestic demand has led to an increase in the expected growth rate of companies, and the capital investment cycle of companies is recovering strongly. What

Four.The unemployment rate is declining due to labor shortages, and the strong expansion of total wages is expected to generate new products and services through corporate investment.

Five.An improvement in the earnings environment due to a recovery in consumption will lead to an upswing in the corporate capital investment cycle, and in fiscal 2025, the corporate savings rate will become negative (normalize). Momentum for overcoming structural recession increases

6.Expanding domestic demand and improving productivity through investment will begin to push up the potential growth rate, and the Bank of Japan will begin raising its long-term interest rate target in a way that does not impede economic and market expansion and the acceleration of the inflation rate.

7.With the inflation rate stabilizing at the target level of 2% and inflation expectations anchored, the government declared a complete exit from deflation in fiscal 2026, and the Bank of Japan returned its short-term policy interest rate target to positive, embarking on an easing policy. break away from

8.Economic expansion will accelerate as the corporate savings rate declines, and the fiscal balance will move out of the red in fiscal 2027 due to an increase in tax revenues.

Risk Scenario – Premature Policy Tightening

1.Due to the spread of new mutant strains and geopolitical problems, the recovery of economic activity has been delayed, the burden of corporate debt has increased and policy support has diminished, or the Bank of Japan hasty monetary policy normalization due to fear of yen depreciation. credit cycle crumbles as

2.Overwhelmed by concerns about the financial burden, they turned to austerity measures such as tax increases, again extinguishing the net demand for funds, and breaking down the reflation cycle.

3.Global policymakers are overly wary of inflation, rushing to tighten policies, and overkill economic activity, leading to economic crises centered on emerging countries.

Four.Japanese companies are unable to keep up with the expansion of global investment activities, and lose their competitiveness rapidly.

US Main Scenario: Policy Mix of Monetary and Fiscal Tightening

1. The economy is expected to enter recession in the second half of 2023, and an interest rate cut is expected in the first half of 2024.

• FF interest rate is expected to be 4.25-4.50% at the end of 2022 and 4.75-5.00% at the end of 2023
• Maintain a hawkish stance until the employment supply-demand balance is eased (suppression of demand = worsening of employment)
• No rate cuts until inflation slows to around 2%: 2024
• Fiscal policy is also expected to be restrained
• The conditions for the suspension of Fed rate hikes are a slowdown in the rate of wage growth (= deteriorating employment) and continuous reduction in CPI (PCE) increase (especially on a month-on-month basis).

2. The unemployment rate will worsen by about 2 percentage points, suggesting a relatively “shallow” recession

• The employment deterioration (economic downturn) is expected to become apparent in the latter half of 2023
• Lehman shock, rather than an economic downturn on the scale of the COVID-19 pandemic, we assume a relatively shallow and mild recession
• The bank’s financial soundness is maintained, and serious credit concerns will not occur
• Assume that excessive monetary tightening will be avoided
• Will the economic cycle turn around in 2024?: The Fed’s dovish turn will bring asset prices back and high inflation will subside, leading to recovery in investment/consumer sentiment

Eurozone Main Scenario: Government-ECB Coordination

1. Economic slowdown through the end of 2022, economic recovery after 2023, inflation control and fiscal support are key

• Energy and food price inflation due to the Russia-Ukraine conflict is the biggest drag. Inflation peaks out by the end of the year.
• The ECB will end rate hikes at 2.5% by the end of 2023. Achieving a soft landing requires financial support such as subsidies. Germany’s fiscal stance has shifted to expansion.
• After 2023, the economy will recover due to the resolution of supply constraints and energy supply problems.

2. Risk factors are energy, inflation and a weak euro

• If the energy supply problem is not resolved, energy-led inflation will arrive in the winter. If government-led energy usage restrictions are issued as energy saving measures, corporate activities will be pushed down.
• If the European and US monetary policy stance continues to diverge and the euro continues to depreciate, inflation risk will increase.
• If the Russia-Ukraine conflict is prolonged, an energy embargo and expansion of sanctions are also possible. Consumption and investment will not recover until sentiment recovers.

Foreign Exchange – Monetary policy stances continue to diverge, driven by yen depreciation

The Fed places great importance on curbing inflation, and we believe it will continue to raise interest rates despite concerns about an economic slowdown. The policy interest rate outlook (dot chart) at the end of 2023, announced at the September 2022 meeting, shows a median of 4.6%.

For the Fed to turn dovish, a clear decline in inflation will be necessary, which we expect will be accompanied by a recession due to a sharp decline in demand. In 2024, the FRB is expected to cut interest rates, and the environment of strong dollar and weak yen is expected to change. We expect the ECB to raise interest rates by an additional 1.5 percentage points until early 2023. The current high inflation is a global phenomenon, and the timing of the stabilization of prices in the euro area will likely follow that of other countries, such as the United States. Therefore, we expect the ECB to change its hawkish stance in 2024.

While maintaining the current monetary easing framework, the Bank of Japan expects the government to implement a large-scale economic stimulus package in October 2022, along with a growth strategy that includes expansion of government growth investment. It is expected that the form of aiming to break out of the structural recession will be firmly maintained.

These moves will support the yen’s current level of weakness against the dollar and euro. As a risk scenario, if the Bank of Japan were to make adjustments to tighten its monetary easing policy, the credit cycle would falter, companies would go into deleveraging and restructuring, the economy and markets would bottom out, and the yen would appreciate badly. It is conceivable that deflation will reignite.

Turning nominal GDP and aggregate wages from contraction to expansion was the greatest achievement of Abenomics. It was the first time since the bubble period that the nominal GDP growth rate, which is the force of expansion, has consistently exceeded the long-term interest rate, which is the force of restraint. Long-term real interest rates were negative. The expanding force exceeded the restraining force, and the deflationary contraction equilibrium changed to the reflationary expansion equilibrium.

Due to the rapid contraction of nominal GDP due to the new coronavirus problem, it was temporarily allowed to reverse again. However, by monetizing the revival of net demand for funds through aggressive fiscal policy through aggressive monetary easing by the Bank of Japan, the recovery of nominal GDP outweighs the rise in interest rates, and a new expansionary equilibrium with negative long-term real interest rates is expected to take the form of deflation. It will continue until complete expulsion.

As the virus problem recedes, the real GDP growth rate will become self-sustaining, driven by domestic demand. In response to the global tightening of monetary policy, the correction of monetary easing by the Bank of Japan, which aims to break out of deflation, will be the last. will become sustainable and help Japan overcome deflation.

After confirming that the corporate savings rate has turned negative, the Bank of Japan will likely begin raising its long-term interest rate target in fiscal 2025 at a speed that does not impede economic and market expansion and the acceleration of the inflation rate. The short-term policy interest rate target will return to positive and the current easing policy will begin to break away in FY2026 when the 2% inflation target is achieved and the government can declare a complete exit from deflation.

▽ Nominal GDP growth rate and long-term interest rates

▽ Japan’s economic outlook

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