Turning Japanese? I really don’t think so for Britain, Liz Truss
The Foreign Secretary wants to take a leaf out of Japan’s book, the world’s most indebted rich nation
Right, I think I can guess what’s happened here. Imagine you’re madly cramming for a series of Tory party leadership debates. You’re going to be asked about a lot of stuff. High up on the list will be the cost of living crisis. This is partly the result of soaring inflation. What will you say about how you’re going to deal with it? Err…
Ok, well, which developed economies around the world don’t have a problem with rising prices? Oh look, Japan’s doing alright. The annual inflation rate was just 2.5pc in May. Bingo. You can say your government would get the Bank of England to take a leaf out of the Bank of Japan’s (BOJ) book. Perfect. Right, let’s move on to defence spending.
Implausible? How else do you explain the latest bizarre twist in the Tory leadership fight. The Bank of England was dragged into the melee over the weekend with the various candidates to become the next prime minister criticising its inability to control inflation.
The Bank has been operationally independent since 1997. It is charged by the Treasury with maintaining inflation at around 2pc. The figure is currently above 9pc and likely to rise into double figures in the coming months. The leadership hopefuls have therefore correctly spotted a problem.
It’s the mooted solutions – such as they are – which might raise more than a few eyebrows.
In the leadership debate on Sunday evening, Liz Truss, the Foreign Secretary, said that the “business-asusual economic strategy” isn’t working and the next government should look at other countries that have been more successful at controlling inflation.
She cited the BOJ as one possible example to follow.
It’s – how to put this? – an interesting choice. While soaring inflation definitely isn’t great, there’s one thing that’s arguably worse and that’s chronic deflation. If prices are constantly falling, everyone holds off making purchases until the thing they want to buy gets cheaper and the economy gums up.
That’s been the fate of the Japanese economy more or less continually since the mid-1990s. It is the reason the country suffered what was widely described as the “lost decades” with its economy treading water while the rest of the developed world swam on.
There are plenty of interconnected reasons for Japan’s persistent deflation. But the country’s central bank deserves at least part of the blame.
The troubles can be traced back to the country’s huge asset price bubble in the 1980s when the country’s stock markets and real estate prices went stratospheric. At one point, Japanese companies had so much cash that they started bidding up the price of paintings by Van Gogh.
When things inevitably went pop, as they did in 1991, it led to a long period of low growth, falling prices and almost continual banking crises.
An ageing population, declining productivity and a long-term negative output gap (which results in spare capacity pushing down prices) made it hard for the economy to drag itself out of this stagflationary trough. The
‘The econony was in a stagflationary trough. The solution the Bank of Japan came up with was a fancy new lark called quantitative easing’
solution that the BOJ came up with was a fancy new lark called quantitative easing. It embarked on this monetary experiment back in 2001 and has since engaged in an asset-purchase programme that makes other central banks look like mere dilettantes.
Indeed, following the financial crisis, the BOJ was in danger of running out of bonds to buy and started snapping up shares through exchange-traded funds.
Today, its balance sheet is bigger than Japan’s entire $5trillion (£4.2trillion) economy.
But those trillions of dollars of fiscal stimulus has had limited success and many perverse unintended consequences.
For one thing, it has resulted in the nation’s banks becoming incredibly risk averse, preferring to hoard government bonds on their balance sheets rather than lend to potentially productive companies in the private sector. Some would argue that it has also artificially weakened the yen, which has allowed companies and the government to avoid making the hard choices necessary to increase productivity and raise competitiveness. Why bother rolling up your sleeves and doing the hard graft when there’s endless free money sloshing around?
Of course, since the financial crisis, other central banks have indeed taken a leaf out of the Boj’s book and embarked on their own quantitative easing programmes.
Future textbooks will be written about whether Japan’s unique circumstances lulled policy makers into thinking they could continually boost the money supply without stoking inflation.
One thing appears relatively clear already. Global governments have effectively outsourced the management of the economy to their central banks for the best part of fifteen years. And that tactic is getting old very fast.
Keeping interest rates so low for so long has reduced the potency of monetary policy. Central banks are increasingly “pushing on a string”.
Nowhere is this more true than in Japan. There is growing evidence that the Boj’s easy money policies have produced only illusory growth at best.
The more the country’s policymakers have tried to stimulate the economy, the less it has reacted.
Japan is now the most indebted rich country in the world with a debt-to-gross domestic product ratio of 257pc.
And yet the BOJ is sticking well and truly to its guns.
In June, it reaffirmed its policy of “yield-curve control”, which is designed to keep yields on 10-year Japanese government bonds at around 0pc. With most other central banks hiking rates, it’s now swimming against the tide.
The yen has plunged by 15pc against the dollar so far this year.
Is this really Truss’s plan? In economic terms, “turning Japanese” is widely considered something that politicians and policymakers should be actively seeking to avoid.
If Truss genuinely thinks it’s a model to emulate here, rather than just a pat answer to a tricky question, she’s very badly mistaken.