The Japanese Economy and Austerity Measures
The Japanese economy has long been impacted by austerity measures implemented by the state government. The major goals of such policy are to manage the expanding economy and slow it down during the growth phase of the cycle, as well as to protect against "overheating" and other difficulties. It is feasible to strengthen the national currency by restrictive policy and so boost import trade activities, as the identical goods and services will be relatively cheaper in local currency. Infrastructure, machineries, new technology, and patents are examples of strategically important products and services that may come from other countries. Also, application of such measure as raising interest rates and sales of government bonds makes foreign investments into the country more attractive option for investors. The other tool, applicable to this police is raising tax rates that are unfavourable for business and may lead to closing some inefficient companies, allowing the labour and other markets to reorganise resources more optimally.
Turning Away from Austerity Policies
Today governments are turning away from austerity policies as soon as many developed economies come to the state of deflation and recession, the situation that is dangerous for economic growth when agents are saving too many sources and formed expectations lead to the next savings. In that position, commercial agents with time may find they have not enough money for the efficient exchange of goods and services, and they have no interest and ability to buy products and services by other agents. The next deflation spiral will make stimulus for business weaker and amount of money available for agents less on every cycle, the probable outcome will be a growing unemployment, slowing down inflation, and diminishing GDP
Stimulating Measures in Modern Economies
In the modern market economy, the growth and prosperity associated with the higher GDP and more active transactions between economic agents. Therefore, the situation described above is inappropriate, and the states use restrictive policy rarely. More popular measures in the modern economies of the developed world are stimulating, the system of "cheap money" and quantitative easing heavily applied by US administration, in EU, and as I can see from the case in today Japan.
Weak Consumption in the Japanese Economy
One of the problems in the current Japanese economy is a weak consumption. In more strict terminology, the low level of aggregate demand, that provides negative stimulus for business and lead to a recession. Within the category of aggregate demand, economists divide three essential parts: the planned government spending (G), the planned consumption (C), and the planned investment (I). An additional term that applies to the open economy trading with the other countries is a net export (Ex-Im), the difference between import and export. As is clear from the Japanese case in the current Japanese economy the components C and E of aggregate demand (AD) are low.
Influencing Aggregate Demand
For demand stimulation, the state can affect various components directly and indirectly through the fiscal and monetary policy. First, it can increase the planned government spending (G); this measure in dependence on particular spending directions may affect both the planned consumption and the planned investment. In the case of Japanese economy and actions planned by the administration will affect consumption through the payments to low-income population and investment through spending to infrastructure projects. The effect of multiplication will make the faster circulating C component probably more gaining than I component (see figures below).
Impact of Government Expenditures
The figure below (4.2) illustrates the direct effect on the AD by government expenditures. The raising G component shifts the AD curve up formally not affecting consumption function, the equilibrium point's income for this new position is higher. Figure 4.4 shows the indirect impact of government expenditures coming from multiplication effect and supporting by introduced into economy sources operations with a higher value than the initial sum (in the example it is L600 from L300 spending).
Tax Cutting and its Effects
The other measure relevant for stimulation consumption is a tax cutting, through this action the state leave more sources available for spending to customers and business; however, in the situation of negative expectations they can decide to save these additional sources instead of spending them in the short-term period. Therefore, the possible effect of tax cutting has the other pattern, the comparison between results of these measures easy to make using the graphical method. Impact of these actions is shown in figures 5.13 and 5.14. While direct government spending shift AD and IS keeping the slope, tax cutting change the slope of the AD and IS changing it differently for various levels of Y (output or income) as soon as the tax share is a % of income but not a fixed amount.
Specifics of Japanese Case
While talking about Japanese situation in more details, it is reasonable to discuss the specific structure of planned expenditures and related trends and expectations. First, the government spending in 2017 and the next period will be Ä56.2tn in total, in 2017 it will reach the level of 0.9 GDP or Ä4.6tn (Ä45bn). As soon as people in the economy is less rational than ideal models, the outcomes of actions will be affected by psychology. An essential factor is expectations and in this context, the government spending higher than the one of previous year can have a weaker effect. The reason for it is past information about much larger planned government spending up to Ä28.1tn. The gap between expectations and reality may lead to weaker results by the action. The other measure that conflicts with the current plans is a previous raising of consumption tax from 5% to 8%, the measure relevant for restricting policy, but not a stimulating remedy. Taxations changes, on the one hand, provides the population with the stimulus to spend less and on the other diminish the slope of the AD and IS curves that lead to the lower Y at the equilibrium point.
The Promised Structure of Spending
The promised structure of spending will include Ä2.5tn in welfare spending, Ä0.6tn for small and medium-sized businesses, Ä1.7tn for infrastructure, and Ä2.7tn for reconstruction after an earthquake. Within the welfare spending, payments have clear directions; they are childcare subsidies and fees to the list of registered low-income individuals (mostly pensioners, Ä15,000($147) in one hand to 22m receivers). The other part of planned expenditure provided in the form of soft government loans for the construction industry (in particular, finishing maglev train line) has a more extended period until measurable effects and therefore much less transparent. By the opinion of Harding, an impact on the part addressed to low-income individuals will be fast, while one by infrastructure spending may be much weaker and slower. This thesis is in concordance with the theory provided above.
Mechanics of the Construction Industry
The possible mechanic for the construction industry and its indirect long-term effect will be as following: the G spending will reach Japanese big business that will employee smaller companies that will spend sources to materials and salary to employees that will pay it to consumption. These sources reaching banks will partly go to reserves due to central bank requirements and partly lent to business and individual consumers again. Two additional factors affecting the multiplication within the economy are taxes and imports. Both in the case of Japan will hurt the efficiency of measures. The raised taxes on consumption will lead to faster absorption of money from the circulation during this process and less possible cycles of money flow. The strong yen giving import preference over export operations will also lead to absorption of local currency and migration of financial capital abroad that should diminish multiplication. However, in a long-term, the stimulating politic itself should lead to currency weakening and some more balance.
Shifting the IS Curve through Monetary Policy
The AD shifts and changes in the real economy lead to the corresponding changes for IS curve and therefore shifts on the money market. Thus, the Japanese package of stimulus would provide the IS curve shifted to the right-up corner and having a higher negative slope. The resulting Y by combined changes in spending and taxation will be less than one by just initially expected to spend.
Monetary Policy Measures
The monetary policy measurements available for stimulating economy includes decreasing of interest rates, decreasing reservation requirements for banks, and operations of the central bank (and government as a producer of bonds) on the open market including running buying back of state bonds. The monetary policy measures, in general, has a less predictable effect and works slower than fiscal. In the Japan, the interest rates for a long time have been ultra-low (zero yields for government bonds with terms up to 10 years) that makes next diminishing impossible. On the other hand, the Japanese public net debt is 128% of GDP and the cyclically adjusted deficit – 5% of GDP. That gives space for buying back bonds for stimulation as a monetary measure but limiting the fiscal policy on the part of sourcing planned spending. The other possible sourcing by taxation is also conflicting the goal of economy stimulation, and this is the Japanese case. However, money absorbed by the state through tax and spent then for economic stimulus and supporting particular social classes play an important role in covering market fails.
Effects on Employment
Finally, the specific feature of Japanese case is an almost full employment conditions. Application of described measures in this situation will have limited effects as soon as stimulated business has few variants for recruiting. Possible scenarios are competition for labour with growing salary and inflation or involving migrants from other markets who can also cost more or less than local workforce in dependence on origin and qualification.
Reflections
a. What were the main challenges that you encountered while working on the questions in this TMA and the associated iCMA?
b. Did you find any aspects particularly difficult?
c. To what extent did you overcome the challenges that you have identified?
d. Would any other support have been helpful?
