Escalating public debt inevitably drives prices higher. But growing government debt can still pose a threat to price stability even before it begins to spiral out of control.The Bundesbank(German pdf) now modeled the effect of Abenomics on growth and inflation to end the fight Weidmann v. Weidmann on the effect of public debt on inflation.
Abenomics consists of three "arrows". On the monetary side the inflation target has been increased to 2 % from 1 %. Fiscal spending will also be increased by 2 % and structural reforms will be the third arrow. In April 2014 the consumption tax will most likely be increased from 5 % to 8 % and in 2015 there will be a further increase to 10 %.
We can clearly see that Abenomics will escalate public debt in 2013. The deficit might rise to 11.5 % this year. So, the Bundesbank's model also tested which Weidmann is right. The result is of course that the fiscal policy which directly influences inflation significantly is the consumption tax increase in the next two years. Additionally, the model shows clearly that expansionary policy is expansionary and contractionary policy is contractionary. So, for the year 2013, the Bundesbank assesses that both fiscal and monetary policy together will increase GDP growth by around 1.25 percent. In 2014 the increased VAT will reduce the the positive influence of the fiscal policy, which is faded out that year, while monetary policy will keep increasing growth. In the beginning of 2015, the further VAT increase will become the dominating force which will be a drag on growth. (page 17 graphic: effect on GDP, effect on yoy GDP growth, effect on yoy inflation).
So, according to the Bundesbank neither Weidmann is correct. In fact, if the model is anywhere close to reality, then Abenomics will work as advertised. Since, the Bundesbank hates fiscal stimulus it argued against it, anyways. On page 19 they give an excellent reason why fiscal stimulus is bad:
Also, any positive growth effects [of fiscal policy] are opposed by increasing fiscal risks, which result from a anewed expansion of the already very high public debt; and these [risks] will also constrain the room to maneuver in future expansive programs.Expansionary fiscal policy is bad since it reduces the chances for future expansionary fiscal policy. I really like this logic. They argue against both the expansion and the following contraction because both might be pro cyclical. VAT increases are one of the structural reforms that the OECD suggests for Japan. But overall the Bundesbank assesses:
All things considered, it can be declared that the policies of the Japanese government are, according to the model, suitable to increase the inflation rate in the long term in accordance with the new inflation target; and to stimulate the economy in the short term.I have one big problem with the model, though. Recent experience in Greece and Spain has clearly shown that increasing the VAT causes a much higher inflationary effect than was expected. These finding do not seem to have entered the model of the Bundesbank, as they expect a very mild effect.
So since Abenomics is suitable for the goals according to the Bundesbank let's see what the German newspapers write.
FAZ: "Bundesbank is openly sceptical of Japanese economic policy."
The article is actually OK. They mention everything that is relevant, it is just a tad sensationalist.
Handelsblatt: "The ultra easy monetary policy will only help the Japanese economy in the short term, the Bundesbank fears. In the long term it will have negative consequences - especially for inflation."
Well, no. The newspaper which would like to be helping investors, fails miserably.
Focus: "The economic policy of the Japanese government could miss its goal at least in the long run, according to Bundesbank calculations."
Well, perhaps different calculations might suggest that.