Japan’s general election on 16 December was won by the centre-right Liberal Democratic Party (LDP), led by Shinzo Abe. It gained a two-thirds majority in the lower house. It returns to power after losing to the Democratic Party in 2009. Previously it had been in office for most of the time since 1955.
The LDP has promised to revive the flagging Japanese economy, which has been suffering from years of little or no growth and returned to recession last quarter. Economic confidence has been damaged by a dispute with China about the sovereignty over some small islands in the East China Sea. The economy, whose exports make up some 13% of GDP, has suffered from the global slowdown and a high yen. The yen has appreciated against the dollar by around 40% since 2007.
The economy has also suffered from the shutdown of all its nuclear reactors following the earthquake and tsunami last year. Nuclear power accounted for over 30% of the country’s electricity generation.
Mr Abe promises to revive the economy through fiscal and monetary policies. He plans a fiscal stimulus package in early 2013, with increased government expenditure on infrastructure and other public-works. He also wants the Bank of Japan to increase its inflation target from 1% to 3% and to achieve this through various forms of monetary easing.
The initial reactions of markets to the election result were favourable. The stock market rose and the yen fell.
However, as the following articles discuss, there are dangers associated with Mr Abe’s policies. The expansionary fiscal policy will lead to a rise in the country’s general-government debt, which, at some 240% of GDP, is by far the largest in the developed world. This could lead to a loss of confidence in Japanese debt and a fall in the price of bonds on the secondary markets and a rise in government borrowing costs. Also, a depreciation of the yen, while welcomed by exporters, would increase the price of imports, including food and raw materials.
Using macroeconomic data from sources such as sites 6, 7 and 9 in the Economics Network’s Economic Data freely available online, describe Japan’s macroeconomic situation over the past 10 years.
Why has the Japanese yen appreciated so much in recent years?
What forms could monetary easing take in Japan?
Why might it prove difficult to stimulate the Japanese economy through fiscal and monetary policies?
What undesirable side-effects might result from expansionary fiscal and monetary policies?
What structural weaknesses are there in the Japanese economy that have hindered economic growth? What policies might the new Japanese government pursue in tackling these structural weaknesses?
If aggregate demand were to expand, would there be sufficient spare capacity to allow aggregate supply to expand to meet the additional demand? This is the question addressed by the podcast and article below.
If there is plenty of spare capacity, policies to increase aggregate demand could help to take up the slack and thereby achieve economic growth – at least as long as spare capacity remains. In other words, in the short run the aggregate supply curve may be horizontal or only gently upward sloping at the current point of intersection with the aggregate demand curve. This is illustrated by point a in the diagram. A rightward shift in the aggregate demand curve would cause a movement along the aggregate supply curve to a new higher level of real national income (Y).
If, however, there is little or no spare capacity, an increase in nominal aggregate demand is likely to be purely inflationary, or virtually so. This would the case at point b in the diagram. Real national income cannot expand beyond the full-capacity level, YFC. Under such circumstances, any attempt by the government to stimulate economic growth should focus on the supply side and attempt to shift the aggregate supply curve to the right. Examples of supply-side policy include incentives to encourage research and development, incentives for the private sector to invest in new capacity and direct public investment in infrastructure.
Unemployment is not just caused by a lack of aggregate demand relative to aggregate supply. It may be the result of a mismatching of labour supply with the demand for labour. People may have the wrong qualifications or not be where the jobs are. Unemployment may co-exist with quite high levels of vacancies. There may be vacancies for highly qualified scientists, technicians or craftspeople and unemployment of people with low skills or skills no longer in high demand. The same may apply to capital equipment. There may be a shortage of high-tech equipment or equipment to produce goods in high demand and redundant older equipment or equipment in areas of declining demand.
Part of a comprehensive set of policies to tackle unemployment and achieve economic growth would be to focus on the whole balance of the economy and the matching of the demand and supply of inputs.
Many developing Asian countries have experienced rapid and yet relatively stable economic growth over a number of years. In other words, this has not been a short-term unsustainable boom associated with the expansionary phase of the business cycle – with aggregate demand expanding more rapidly than aggregate supply. Rather it is the result of a rapid growth in aggregate supply.
Over the period from 2000 to 2011, several Asian countries experienced average annual growth rates of over 4% and some, such as China and India, much more than that, as the following table shows. The table also shows forecasts for the period from 2012 to 2017. The high forecast growth rates are based on a continuing rapid growth in aggregate supply as the countries invest in infrastructure and adopt technologies, many of which have already been developed elsewhere.
But for aggregate supply to continue growing rapidly there must also be a stable growth in aggregate demand. With the recession in the developed world, some of the more open economies of Asia, such as South Korea, Taiwan, Malaysia and Singapore themselves suffered a slowdown or recession as demand for their exports fell. The Malaysian economy, for example, contracted by 1.5% in 2009.
Given the continuing macroeconomic problems in the developed world, many Asian countries are seeing the need to rebalance their economies away from a heavy reliance on exports. China, for example, is putting more emphasis on domestic-led demand growth. Others, such as Indonesia, have already embarked on this route. As The Economist article states:
Household consumption contributed half of the growth of just over 6% Indonesia enjoyed in the year to the third quarter (its eighth consecutive quarter of growth at that pace). Exports have fallen from about 35% of GDP ten years ago to less than a quarter in 2011. Developing Asia’s combined current-account surplus, which reflects its dependence on foreign demand, more than halved from 2008 to 2011 and is expected to fall further this year.
The continuing success story of many developing Asian economies thus lies in a balance of supply-side policies that foster continuing rapid investment and demand-side policies that create a stable monetary and fiscal environment. A crucial question here is whether they can emulate the ‘Great Moderation’ experienced by the Western economies from the mid-1990s to 2007, without creating the conditions for a crash in a few years time – a crash caused by excessive credit and an excessively deregulated financial system that was building up greater and greater systemic risk.
UK Unemployment figures for the July to September period have just been published. Perhaps surprisingly, the rate has fallen to 7.8% from 8.0% in the previous 3-month period. What is more, there have been similar 0.2 percentage-point falls in each of the two 3-month periods prior to that (see chart below).
This would normally suggest that the economy has been growing strongly and faster than the growth in potential output. But, despite positive economic growth in quarter 3 (see A positive turn of events?), the economy has been experiencing a prolonged period of low or negative growth.
So what is the explanation for the fall in unemployment? (For a PowerPoint of the chart, click here)
One reason is a greater flexibility in the labour market than in previous recessions. People are more willing to accept below inflation wage increases, or even nominal wage cuts, in return for greater job security. Others are prepared to reduce their hours.
The other reason is a fall in productivity (i.e. output per hour worked). One explanation is that people are not working so hard because, with a lack of demand, there is less pressure on them to be productive; a similar explanation is that firms are ‘hoarding’ labour in the hope that the market will pick up again.
Another explanation is that employment growth has often occurred in the low productivity industries, such as labour-intensive service industries; another is that when people leave their jobs they are replace by less productive workers on lower wages; another is that workers are making do with ageing equipment, whose productivity is falling, because firms cannot afford to invest in new equipment. An range of possible explanations is given on page 33 of the Bank of England’s November 2012 Inflation Report.
But with many predicting that growth will be negative again in 2012 quarter 4, the fall in unemployment may not continue. Britain may join many other countries in Europe and experience rising unemployment as well as falling output.
What possible explanation are there for the latest fall in unemployment?
What has been happening to employment, both full time and part time?
What are the different ways of measuring productivity? Why will they be affected differently by a fall in the average number of hours worked?
Why might it be in firms’ interests to maintain the level of their workforce despite falling sales?
Assume that there has been a fall in aggregate demand. Compare the resulting effect on consumption of (a) a fall in wages rates; (b) a rise in unemployment. How might the design of the benefit system affect the answer?
In an attempt to kick start the UK housing industry, the government has proposed a series of measures to reduce regulations.
These include relaxing planning restrictions on building extensions to existing homes, shops and offices; relaxing current rules that all new housing developments should include affordable housing (which often makes little or no profit for the builders); an extra £280m for the FirstBuy scheme that provides loans to first-time buyers to raise money for a deposit; and a new “major infrastructure fast track” scheme, whereby developers of large commercial and residential projects currently stalled at local authority planning level can have their applications ‘fast tracked’ by the national Planning Inspectorate.
The government maintains that the measures will increase the flow of new houses coming onto the market by reducing ‘red tape’.
Critics maintain that the problem of the slump in house building has little to do with a lack of availability of new houses or new plots for building. Rather, it is a reflection of the recession in the economy as a whole. The solution, claim critics, is to stimulate the economy and then the new-build property market will recover along with other sectors.
The articles look at the likely success of these latest policy proposals for the property market.
Japan’s general election on 16 December was won by the centre-right Liberal Democratic Party (LDP), led by Shinzo Abe. It gained a two-thirds majority in the lower house. It returns to power after losing to the Democratic Party in 2009. Previously it had been in office for most of the time since 1955.
Mr Abe promises to revive the economy through fiscal and monetary policies. He plans a fiscal stimulus package in early 2013, with increased government expenditure on infrastructure and other public-works. He also wants the Bank of Japan to increase its inflation target from 1% to 3% and to achieve this through various forms of monetary easing.
