Monday, August 19, 2013

Bundesbank Now a Fan of Abenomics?

The Bundesbank really has not been a fan of Abenomics. Jens Weidmann the president of the Bundesbank assessed in an interview with Deutschlandfunk in April, for example, that the causes for "the deflationary development and the restrained growth [in Japan] are not lacking liquidity, but are of a structural nature, a demographic nature, but also are due to the high public debt." Therefore a sound government policy should tackle these issues, he said. Jens Weidmann the president of the Bundesbank disagrees. In a speech at the end of last year he assessed:

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.
These three are the only news articles which could be found with google news at the time of writing. Focus and Handelsblatt additionally fail to mention the consumption tax increases, which are probably not all that relevent since they only amount to a doubling within two years. All of the articles base their assumption on a sentence which mentions "straw fire", which in my opinion shows that there is also a not so scientific force at work within the Bundesbank, let's call it the feely side (the initial quotes could be considered an indicator pointing in some direction). In fact, the model clearly shows that Abenomics will have an overall positive effect on GDP, well into the next decade. The feely side focused on the effect of the VAT increases and on the slightly negative effect that the model shows for the yearly growth rate three years in the future. It would make sense for newspapers to maybe sometimes actually look at what they are reporting on, otherwise they might just be misled.

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