Japan's bizarrely brief "technical recession"

by Michael Collins, Investment Commentator at Fidelity

January 2016

Revisions are a normal part of compiling economic statistics, especially when it comes to the all-encompassing national accounts that track GDP. The Australian Bureau of Statistics, for instance, normally allows up to 16 quarters of revisions for original current-price and chain-volume estimates for a September-quarter national accounts publication. There are many other adjustments on top of that as more information comes to hand or better statistical practices are employed.[1] Sometimes quarters of negative growth are revised away. Few noticed that Australia’s negative GDP result for the September quarter of 1993, which ranged over time from -0.4% to -0.1%, reached zero by the September quarter of 2011 and since then has ranged from 0% to growth of 0.1%.[2] If only the body that gauges Japan’s economic growth could make such unnoticeable revisions.

On November 16, Japan’s Cabinet Office shattered investor confidence in “Abenomics” when it reported that the world’s third-largest economy shrank at an annualised rate of 0.8% in the September quarter.[3] The damage wrought by the Office’s “first preliminary” reading on Japan’s economy was not so much the negative result itself. It was the fact that after shrivelling an annualised 0.7% in the June quarter, Japan was now deemed to be in recession by those who use the amateur definition of a recession as being two consecutive quarters of negative growth – a so-called technical recession. (Credible economic bodies judge an array of economic indicators including GDP growth before declaring the start and end of recessions.)

But 22 days later, what was supposedly the second technical recession since Prime Minister Shinzo Abe took office in 2012 and Japan’s fifth technical recession in seven years was revised away. The Cabinet Office’s “second preliminary reading” judged that Japan grew at an annualised rate of 1% in the September quarter (a revision that rekindled debate on the competence of the Cabinet Office, which advises Japan’s cabinet on high-level issues, at measuring GDP). This means that Japan’s economy eked out 0.2% annualised growth over the two quarters.

Even if Japan never was in technical recession in 2015, the fact is that Abe’s radical economic remedies, or “three arrows” as he calls them, are failing to revive Japan. Unprecedented monetary policy, splashes of fiscal stimulus and sporadic microeconomic reform are yet to propel Japan’s economy out of two-and-a-half decades of deflation-prone torpor. Consumer inflation was just 0.1% in the 12 months to November.

Many analysts urge Abe to push harder on the structural-reform arrow because fiscal stimulus would only add to record government debt and the central Bank of Japan’s quantitative easing is nearing the end of its usefulness. Abe will no doubt seek more improvements to boost productivity and will probably inject some small targeted fiscal stimulus. Chances are, however, that if Japan’s economy keeps spluttering Abe will turn his radical remedy for Japan into a revolutionary one. Abe’s best hope of beating deflation is to resort to “money printing” in the original (and correct) meaning of the term. Just as the Japanese inventions of zero interest rates in 1991 and quantitative easing in 2001 became credible policies for other developed countries, so too could money printing become a serious option for authorities in advanced countries if Japan implements the practice. It will always prove contentious, though, as it can go widely wrong.

Japan’s economic challenge is that some of the country’s long-standing problems are almost immune from pure economic cures. A declining and ageing population is dampening consumption and shrinking the workforce by about 1% year. It’s estimated that the resulting labour shortages and drop in consumption limit GDP’s average growth rate over a business cycle to as little as 0.5% (while not necessarily restricting growth in GDP per capita to this extent). Thus, almost no matter the fiscal and monetary stimulus, Japan is destined to function on the brink of recession for some time yet unless the government engineers social change. Such remedies would require the homogenous country to turn to immigration, to push more full-time women into the workforce and persuade younger Japanese to have larger families. As it is, Japan’s economy is not hopeless. It’s expected to have grown 0.5% over 2015 and unemployment is at a 20-year low. For all its languidness, Japan has performed better than the eurozone over the past eight or so years too.[4] But that’s little consolation. Japan’s economy needs to do better. Abe may well feel compelled to follow the prescription Japanese policymakers adopted in the 1930s when they became the first of the major countries’ policymakers to blast their economy out of recession. They did that largely by printing money.  

Flaying shots

In 2014, Abe triggered the now one-and-only “technical recession” under his rule by tightening fiscal policy. Specifically, Abe boosted the sales tax from 5% to 8%. In essence, Abe imposed austerity to tackle Tokyo’s budget deficit and debt, which stands a world high of 246% of GDP in gross terms. The budget shortfall has been reduced from 9% of GDP in 2010 to about 5% now. But, as usual, the austerity measures of 2014 backfired because they hampered consumer spending and added to government debt.

The sluggishness of Japan’s economy these days is not sabotage by Abe but a lack of business investment. Even though corporate profits are at record highs, business spending is sluggish at best, proving more or less flat over the better part of 2015.

But the success of Abenomics is predicated on business efforts. Abe needs companies to invest in new plants and equipment or to share these earnings with their workers by boosting wages. Neither is happening to the degree needed. Instead, companies are compiling record hoards of cash – estimated by the finance ministry to be worth about US$3 trillion. Management teams won’t invest because they see stagnant growth at home and worry about the outlook in emerging markets, especially China. Demand for labour dispels with the need to increase wages.

While the fiscal arrow is fired in spurts, the problem with Abe’s monetary arrow is that it may be losing its punch. The Bank of Japan has had a zero cash rate since 2010 and has already pushed quantitative easing to its apparent limits without achieving its 2% inflation target. The central bank is expanding the monetary base by an unprecedented 80 trillion yen (A$800 billion) a year as it scoops up financial assets or about 8% of the government bonds on issue. By next year, at this pace of quantitative easing, the central bank would own about half the government bonds on issue. Japanese banks, insurance companies and super funds are the biggest owners of Japanese sovereign bonds. But they need to hold onto most of these bonds to meet capital and liquidity requirements and to match assets with liabilities.

As the fiscal and monetary arrows turn problematic, what hope then for Abe’s structural-reform arrow? Alas, it has always proved a wobbly shot. Efforts to make Japan’s electricity and gas markets more competitive, attempts to improve corporate governance and a determination to bring about a Pacific trade pact that would help open up Japanese markets to foreign competition have limited macroeconomic impact. So would any weakening of laws protecting workers, as business demands. They would only add to record profits while undermining consumer-spending power. 

The big ones

Abe, to his credit, is not giving up on reviving Japan’s economy. For him, it’s more a political project to ensure that Japan can prosper – even survive – against a revitalised China. To avoid more austerity, he has postponed another planned increase in the sales tax that was scheduled for October just gone. Abe recently spoke about another stimulus plan that will involve more money for the elderly and boosting minimum wages. He now talks about three new "arrows" – a strong economy, child-care support and social welfare – for he understands social changes are as important as economic remedies.

None of these ideas will matter much for Japan’s economy in the short term at least (and Abe does have an election in 2018 to contest). What other options does Abe then have? His greatest chance of ensuring the success on the inflation front anyway would be to match the efforts of his predecessor Korekiyo Takahashi (1854-1936), a former prime minister and finance minister of Japan as well as an ex-governor of the Bank of Japan. Takahashi’s three-pronged attack thrust Japan out of its 1930-31 depression. The first prong was to take Japan off the gold standard to allow the yen to drop. The second was to lop interest rates. The third was money printing.

Governments print money via fiscal policy, even if a central bank helps dish out the money in its role as the government’s banker. Under money printing, the public is handed money by the government, which is inflationary because money in the hands of the public expands but the amount of goods and services don’t. Instead of selling bonds to fund its deficit, a government gets its central bank to buy the bonds at auction. The central bank does this by expanding its balance sheet just as happens with quantitative easing. (With quantitative easing, the central bank buys bonds in the secondary market from its primary banks through its normal daily market operations. The broader money supply doesn’t automatically increase.)

In advanced countries with low inflation and languid economies, money printing is gaining adherents who advocate the policy option under the title of “Modern Monetary Theory”. Lord Adair Turner, the former head of the UK’s Financial Services Authority (the UK’s ASIC), pushes money printing as a valid option in his 2015 book, Between debt and the devil: Money, credit and fixing global finance. Even more interesting, Jeremy Corbyn, the new leader of the UK’s Labour Party, is an advocate of money printing. He calls in “quantitative easing for the people”.

Other supporters of money printing include Milton Friedman who in a memorable turn of phrase in 1969 facetiously suggested governments could drop the money from helicopters to encourage spending during a time of deflation and depression. In 2002, Ben Bernanke earned the nickname “Helicopter Ben” by proposing that Japan take up Friedman’s suggestion by implementing a “money-financed tax cut”.[5]

The outcry would be immense if policymakers in the developed world ever opted for money printing. (Many emerging governments already do this.) The hyperinflation of the early 1920s in Germany or modern-day Zimbabwe will be used to beat back the suggestion.

But money printing didn’t cause hyperinflation in Takashima’s Japan of the 1930s. Judiciously done, it needn’t spur hyperinflation today. Another benefit of money printing for Japan is that it could enable the Bank of Japan to repay the bonds issued by Japan’s Treasury Department (just as higher inflation eroded its real value anyway). It would probably prove less politically and economically disruptive than Tokyo raising taxes to repay government debt. The Bank of Japan’s buying of ETFs and recent directive that it would prefer to own ETFs that owns companies that are investing in plants or staff in Japan shows the central bank is pushing monetary policy into fiscal-policy territory i.e. towards money printing.

Abe may never take the money-printing option. But if he wants to oversee a stream of positive GDP growth numbers and higher inflation readings, perhaps he should.

Financial information comes from Bloomberg unless stated otherwise.

[1] The ABS normally allows up to 16 quarters of revisions for original current-price and chain-volume estimates for a September-quarter publication. In other quarterly releases, revisions to original current-price (and chain-volume) estimates are restricted to the current year and the previous financial year. For chain volume and price measures, the annual re-referencing of the series each September quarter will cause revisions to the levels for the entire series. Re-referencing does not affect percentage movements, but the introduction of updated price weights for the most recent periods could affect growth rates for these periods. Due to the use of a concurrent seasonal adjustment process, revisions resulting from seasonal re-analysis are allowed to flow through to the whole seasonally adjusted time series each quarter. This concurrent adjustment process was first implemented from September 2006 quarter release 5206.0 onwards, where as previously this reanalysis was only undertaken in the September quarter release only.  

[2] Australian Bureau of Statistics. Data supplied in response to query from Fidelity.

[3] Japan’s Cabinet Office. “What’s new 2015” Archive. http://www.cao.go.jp/en/news/index.html

[4] Japan’s economy regained its record size of 2007 in 2013, a feat yet to be achieved by the eurozone’s economy.

[5] The Federal Reserve Board. Remarks by Governor Ben S. Bernanke. “Deflation: making sure ‘it’ doesn’t happen here.” 21 November 2002. http://www.federalreserve.gov/boarddocs/Speeches/2002/20021121/default.htm