Surprisingly poor second quarter growth numbers in Japan have raised market expectations that there will be snap elections and a delay in the consumption tax hike that was scheduled for October 2015. GDP fell for a second consecutive quarter, by 1.6 percent (q/q, a.r), versus market expectations of a 2.2 percent increase. A huge miss. Falling corporate inventories were a large part of the story, but exports rose only modestly while household consumption and capital spending slowed. The yen sold off after the announcement, reaching a low of 117 against the dollar. Japanese stocks are higher.
Most G-20 policymakers, concerned about global growth, will salute the move by the Japanese government to avoid a fiscal contraction. David Cameron, notably, saying that “red warning lights are flashing on the dashboard of the global economy”, captured the sour mood of this past weekend’s Brisbane Summit. More directly, U.S. Treasury Secretary Lew, in his speech ahead of the G-20 summit, called on Japan to pay
“attention to short-term growth alongside medium-term fiscal objectives. To maintain the recovery and escape deflation, Japan needs to move proactively and decisively to more than fully offset the short-term contractionary impact of the expiration of past fiscal measures and the next consumption tax increase, should Prime Minister Abe decide to proceed with it on the current schedule. The most effective policy would give households short term relief to encourage consumption. A few years ago, in the United States, we implemented a temporary payroll tax holiday to accomplish a similar goal.”
He went on to call for a renewed a structural reform effort, the “third arrow” of Abenomics, on which there has been little progress. Other G-20 leaders made similar remarks. Larry Summers and Paul Krugman reinforced this call for a delay in the tax hike (Paul wouldn’t mind a permanent shift), with the IMF on the other side (though they may soften their view following release of these numbers). Overall, policymakers are right to be concerned about growth, and in this context, Japan is doing the right thing.
The G-20’s cautious endorsement of the delay in the consumption tax hike doesn’t mean that Japanese policy isn’t causing problems for global policy coordination following the recent aggressive monetary easing by the Bank of Japan (BOJ). I have previously endorsed the BOJ’s actions, doubling down on monetary policy, even in the absence of substantial success on the other two arrows of Abenomics. But that means, as far as support for recovery goes—it’s all about the money. A primary channel through which easier money will drive demand is through a significant and continuing depreciation of the yen. The market’s Abenomics (weak yen) trade lives on.
One issue that has not received much attention is that, at the same time the BOJ announced its easing of policy, the government pension investment fund (GPIF) announced a shift in its portfolio away from domestic bonds and into domestic and foreign stocks. Combining monetary easing with direct purchases of foreign stocks is the economic equivalent of direct exchange rate intervention, something the G-20 has previously ruled out. Particularly if the Japanese moves bring forth copycat depreciations elsewhere, this will be a continuing issue for discussion in the coming months, and could find its way to Capitol Hill in the context of upcoming debates over trade policy.