Tag: stimulus

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A J-curve for Japan?

The new Japanese government under Shinzo Abe, which took office on 26 December 2012, has been pursuing a policy of weakening the yen. Using a combination of low interest rates, quantitative easing, expansionary fiscal policy and a declared aim of depreciation, the government has succeeded in driving down the value of the yen.

Since mid-November last year, the yen has depreciated by 28% against the dollar, 30% against the euro and 21% against sterling. The effective exchange rate index has fallen by 22% (see first diagram below: click here for a PowerPoint of the diagram).

But will this depreciation succeed in stimulating the Japanese economy and will it improve the balance of trade? The hope is that the falling yen will boost export sales by making them cheaper abroad, and will reduce the demand for imports by making them more expensive in Japan. The balance of trade will thereby improve and higher exports (an injection) and lower imports (a withdrawal) will stimulate aggregate demand and economic growth.

Traditionally Japan has run balance of trade surpluses, but since July 2012, it has been running monthly deficits – the longest run of deficits since 1980. But depreciation cannot be expected to turn this position around immediately. Indeed, theory suggests that the balance of trade is likely to deteriorate before it improves. This is known as the J-curve effect and is illustrated in the second diagram below. As page 768 of Economics, 8th edition states:

At first a devaluation or depreciation might make a current account deficit worse: the J-curve effect. The price elasticities of demand for imports and exports may be low in the short run (see Case Study 25.1 in MyEconLab). Directly after devaluation or depreciation, few extra exports may be sold, and more will have to be paid for imports that do not have immediate substitutes. There is thus an initial deterioration in the balance of trade before it eventually improves. In Figure 25.12 [the second diagram], devaluation takes place at time t1. As you can see, the diagram has a J shape.

Evidence suggests that the first part of the ‘J’ has been experienced in Japan: Japan’s balance of trade has deteriorated. But there is debate over whether the balance of trade will now start to improve. As the article by James Saft states:

But a look at the actual data shows Japanese companies, like British ones during a similar bout of currency weakness in 2008, appear to be more eager to use a newly competitive currency to pad profits through higher margins rather than higher export volumes. Thus far, Japanese exporters appear to be doing just that. Despite yen falls the price of Japanese exports in local currency has barely budged.

“Japanese companies have not actually cut the foreign currency prices of their exports. Just as with the UK exporters, the Japanese have chosen to hold foreign prices constant, maintain market share, and increase the yen value and thus the yen profit associated with yen depreciation,” UBS economist Paul Donovan writes in a note to clients.

The extra profits earned by Japanese companies from export sales may be stockpiled or paid out in dividends rather than reinvested. And what investment does take place may be abroad rather than in Japan. The net effect may be very little stimulus to the Japanese economy.

As stated by Saft above, the UK had a similar experience in the period 2007–9, when sterling depreciated some 27% (see the second diagram). The balance of trade improved very little and UK companies generally priced goods to markets abroad rather than cutting overseas prices.

But times were different then. The world was plunging into recession. Now global markets are mildly growing or static. Nevertheless, there is a danger that the upward slope of the J-curve in Japan may be pretty flat.

Articles
Weak yen a boon for investors, not Japan Reuters, James Saft (14/5/13)
Japan’s Trade Data Suggest Even Lower Yen Needed Wall Street Journal, Nick Hastings (22/5/13)
2 Misunderstandings About Japanese Trade Seeking Alpha, Marc Chandler (22/5/13)
Japanese trade deficit widens Financial Times, Ben McLannahan (22/5/13)

Data
BIS effective exchange rate indices Bank for International Settlements
Japan’s balance of trade Trading Economics
UK Trade, March 2013 ONS

Questions

  1. Explain the J-curve effect.
  2. Why is there some doubt about whether the Japanese balance of trade will improve significantly?
  3. What will be the consequences for Japanese growth?
  4. If foreign currency prices of Japanese exports do not change, what will determine the amount that Japan exports?
  5. What other measures is the Japanese government taking to stimulate the economy? What will determine the size of the multiplier effects of these measures?
  6. Using data from the ONS plot the UK’s quarterly balance of trade figures from 2007 to the present day. Explain the pattern that emerges.
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‘A new and even stronger era for trade’

International trade brings various benefits to an economy. One is that it can stimulate economic growth – something the UK government would very much like to achieve in current circumstances.

As one of the components of aggregate demand, net exports is a key variable that can create jobs and growth in an economy, and it is this variable that is being directly targeted in a trade agreement between the UK and South Korea. Growth in developing countries is far outstripping that in the West and through this trade deal, the UK is hoping to benefit from some of this growth – to the tune of about £500m per year.

South Korea already trades a huge amount with the UK – we are its second largest European trade partner after Germany. The Free Trade Area that has been agreed will put British firms in a stronger position when negotiating contracts, especially in relation to sporting events, such as the Asian Games in 2014, the World Student Games in 2015 and the Pyeongchang Winter Olympics in 2018. Nick Clegg, who announced the agreement said:

‘The best of British design, innovation and services will have even greater opportunity to show their strength in South Korea. UK and Korean companies will be able to form alliances on multi-billion pound projects across the world.’

Some of the benefits of this agreement may be seen relatively soon, as the South Korea National Pension Service has announced plans to set up a base in London, which would create a much need injection of investment into the stagnant economy. This latest trade deal is very much a part of the Coalition’s strategy of creating stronger ties and trade links to the fast growing emerging markets. The size of these potential benefits and the speed with which they emerge can only be estimated, but if they do materialise they will undoubtedly have positive effects on economic growth. The following articles consider these ‘economic opportunities in the UK’.

Nick Clegg hails Korean trade deal as £2bn opportunity for Britain Telegraph, Anna White (25/3/12)
South Korea trade deal ‘may bring £500m to UK economy’ BBC News (26/3/12)
South Korea’s $320bn pension fund to set up London base Guardian (26/3/12)
S Korea pension fund to set up London office Financial Times, Elizabeth Rigby (25/3/12)
Nick Clegg boosts British business in South Korea The Economic Voice, Jeff Taylor (26/3/12)

Questions

  1. What are the benefits and costs of trade? To whom do they accrue?
  2. The articles talk about a free trade area. What are the characteristics of such an agreement?
  3. What other types of trade agreement are there? In each case, find examples of that type of agreement.
  4. Why is trade seen as an engine of growth? Think about aggregate demand and how this can explain a boost to national income.
  5. If the South Korea National Pension Service does create a base in London, explain how the multiplier effect might create additional benefits to the UK.