Japan's strange inflation debate
Or, fighting fire with gasoline
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I joined Ankit Panda of The Diplomat to discuss the political situation and the US-Japan trade negotiations here.
In a column at the Financial Times, Robin Harding notes that as Japan’s politicians debate whether and how to stimulate the economy, the Japanese government came close to balancing its budget in the first quarter of this year as inflation has pushed up nominal tax revenues. He then delivered a cautionary note to Japan’s political leaders, arguing:
It would therefore be unwise to squander it with tax giveaways or new spending pledges, other than, perhaps, some short-term relief for overstretched households. While deflation continued, stimulus made sense in order to escape it; now that inflation is back, fiscal discipline must return as well. Politicians may find the changeover uncomfortable.
Reading Harding’s column, it occurred to me just how strange the economic policy debate over the past four months have been. In particular, although the upper house elections were ostensibly about inflation – the Kyodo News poll conducted earlier this week, which found that 32.2% of respondents identified combating inflation as the most important issue in the election, is just the latest poll to confirm this – the political parties were not really sparring over inflation as a macroeconomic concept. They were sparring over the cost of living as experienced by ordinary households.
This distinction is critical, because it explains why political parties like the Democratic Party for the People (DPFP) enjoyed considerable success proposing a sweeping across-the-board consumption tax cut financed by deficit spending, a policy that could contribute to worse inflation through multiple channels even if it momentarily made households feel like they were spending less at the cash register. With one hand the government giveth, and with the other the inflation tax taketh away. Voters, looking for higher disposable incomes, were attracting to what looked like a bold solution offered by the DPFP and Sanseitō – and echoed by the Liberal Democratic Party’s (LDP) right wing – to provide more fiscal stimulus, more tax relief, and, presumably, more pressure on the Bank of Japan (BOJ) to keep monetary policy loose, all of which would presumably weaken the yen, making imported food and energy more expensive and fueling the cost-push inflation that has eroded disposable incomes in the first place. In other words, fighting fire with gasoline.1
The DPFP is more or less explicit about its logic in its manifesto: by boosting take-home pay through a consumption tax cut and other tax reforms, it aims to spur a “Reiwa virtuous cycle” driven by rising domestic consumption that would eventually produce faster growth and higher tax revenues. The government should not only spend on tax measures (including, of course, abolishing the temporary gasoline tax) but also on a safety net for young people and industrial policies to spur growth. If you are hearing the echoes of Abenomics in this platform, it is not accidental. DPFP leader Tamaki Yūichirō explicitly described his party’s “new three arrows” as increasing take-home pay, increasing investment, and boost education spending. It is also hard not to see it as inflationary in the near term, presumably what voters care about most.
It is at least somewhat ironic that the LDP and the Constitutional Democratic Party (CDP), both of which underperformed in the upper house elections, have been debating how to provide some relief so that households get a boost to their disposable incomes without encouraging further inflation that would instantly erode their gains. The LDP’s losses are understandable; it was punished for, among other things, allowing inflation to run above target for as long as it has, eroding the nominal wage increases it has sought to encourage.
But the CDP’s losses are harder to explain, or rather, they suggest that policy details matter very little and vibes matter much more.2 The CDP went to extraordinary lengths to craft a carefully balanced manifesto that offers some short-term relief – providing cash subsidies for food costs and cutting the consumption tax on foodstuffs to zero for a year without deficit spending – with proposals to address the underlying causes of inflation, including a raft of measures to boost wages and a pledge to revise the accord between the government and BOJ to lower the inflation target from 2% to roughly 0% in order to reverse the yen’s weakness. For all its efforts to signal that it is genuinely concerned about both inflation and the cost of living, the CDP finished fourth in proportional representation voting behind both the DPFP and Sanseitō.and is having its own debate about its electoral defeat and whether CDP leader Noda Yoshihiko should be ousted.
The reality now is that Ishiba does in fact appear to be, as I suggested following the upper house elections, a dam holding back a rising tide of fiscal stimulus, a government committed to gradual fiscal consolidation and combating inflation that could give way to a new prime minister and ruling coalition committed to supercharging growth through fiscal stimulus to boost take-home pay even at the risk of exacerbating the inflation that led the LDP to this juncture in the first place. In the meantime, if you want to look at how financial markets are judging Ishiba’s chances of staying in office, you could do worse than keep an eye on the yen’s value against the dollar.
And surely to Sanseitō’s chagrin, keeping Japan cheap for foreign tourists.
To be clear, I am fully aware that Japan is hardly the only or even the largest economy to have exactly the same political debate about inflation, complete with bland establishment parties promising uninspiring but responsible policies facing off against populists with a host of contradictory and costly proposals. Indeed, this happened today.