Priorities for the Japanese Economy in 2016 (January 2016)

Calling into Question the Idea of Keeping an Appropriate Distance from "Finance"

GOTO Yasuo
Senior Fellow, RIETI

There is strong concern among market participants that the U.S. monetary policy will be a factor that significantly disturbs the global economy in 2016. Basically, I share this view. The Federal Reserve Board (FRB) is expected to conduct its policy steering very cautiously, but that does not change the fact that the global economy is in a delicate situation. Although the U.S. economy is currently on steady footing, European economies face many concerns such as attacks similar to the Paris terror attacks, the issue of immigration, and the sovereign risk problem. In addition, slower growth in China and other emerging economies has become more noticeable. If the United States, the largest economy in the world, changes its course while other major developed nations continue to significantly ease their monetary policies, it is unpredictable what impact the U.S. decision will have on cross-border capital flows and eventually the global economy.

As a nation with few domestic risks in the immediate future, Japan is unlikely to become fully embroiled in the turbulence of international finance. However, we don't even need to recall the Lehman Brothers collapse in 2008 to be reminded of the fact that if the global economy itself is upset, the impact will be felt eventually. This article will discuss the implications that the wide-ranging area of finance hold for the Japanese economy in 2016 and the years to come, focusing primarily on monetary policy.

Prolonged dependence on finance

While the marked monetary policy easing was a factor that gave rise to the vulnerable structure of the global economy, it is also a fact that the individual monetary policies of countries played an important part in mitigating the shock of various crises. Given the financial insecurity in Japan from the late 1990s to the beginning of the 2000s, the global economic and financial crises after the Lehman Brothers collapse in the United States in 2008, and the sovereign crisis that began in Greece in 2010 and later spread throughout Europe, the global economy would have fallen into an absolute chaos had it not been for substantial monetary easing and an ample liquidity supply.

One problem with the current global economy would be the possibility that the reliance on monetary measures has gone on far too long and has become too extensive. There are two major side effects to this. The first is the possibility that the ample liquidity supplied will destabilize the market. This is exactly one of the factors that have led to the aforementioned concern in the market. The other side effect is the possibility that this will weaken the sense of crisis among policy authorities other than central banks. Although Davig and Gürkaynak (2015) admit the appropriateness of the monetary policy's quick response at the time of crisis, they point out the possibility that it can become permanent and gradually take on a burden other than its original purpose of "stabilizing prices." Today there are measures such as the prudence policy of stabilizing the monetary system, the fiscal policy that requires attention to both discipline in revenues and expenditures and the economic stabilization function, the social security policy for which long-term sustainability is essential, and growth strategies that aim to improve productivity in step-by-step fashion, albeit with temporary pains. I wonder if the structural outline of all of these measures is weakening the original sense of crisis that spread across the world on the back of significant monetary easing conditions.

The global economy can be swayed by finance

Even if dependence on excessive monetary policy may result in unfavorable consequences for the economy in the long run, given the current political and economic situations, it appears that there will be no choice but to continue relying on monetary policy in 2016 and for some time to come in many economies including Japan and Europe. In contrast, the United States has chosen to take a path toward fiscal tightening. In this environment, the global economy is likely to continue to be swayed by finance.

Another new disturbing factor is that China is steadily increasing its presence in the international financial market. In November 2015, the International Monetary Fund (IMF) decided to adopt the Chinese yuan as a constituent currency of the special drawing rights (SDR). China, which up until now has been conducting strict exchange controls, will inevitably liberalize its capital control. Although it is almost certain that the renminbi market will expand internationally if the Chinese economy remains firm, there is a great gap between global standards and the financial infrastructure and the legal system in China. In addition, the future of the Chinese economy itself is becoming increasingly uncertain. The internationalization of the Chinese yuan under such circumstances could pose a new risk factor for the international financial world.

Efforts to control finance

Some say that if finance becomes a disrupting factor, all we need to do is to control it. However, the situation is not that simple. The original purpose of monetary policy is the stabilization of prices, which, in the case of Japan and Europe, means the elimination of deflationary pressure. This goal has not yet been achieved. First of all, finance and the real economy (business conditions and economic growth) are in a bidirectional relationship, and the appropriate lending of funds works positively for the economic activities of companies and households. In addition, fintech and other new forms of financial technology, which have gained much attention lately, will not only make our lives and business management more convenient, but also create jobs because the providers of the new technology will form an industry by themselves.

It is a conventional and novel proposition, but it is important for us to explore new knowledge to appropriately control finance, rather than unnecessarily fearing and avoiding it (Note 1). With the reality that countries have no choice but to rely on finance, Japan needs to make an effort to deal appropriately with finance and control it. To that end, I think there are three perspectives from which we must not waver in this approach. The first is to conduct more in-depth studies and more thorough examinations, making a consistent effort to connect things to the real economy rather than remaining within the logic of "finance." The second is to determine the "appropriate" size and role of finance, instead of looking for a simple vector of promoting or controlling finance in a single direction. The third is to improve the "quality" of finance in a way that allows for the diversification of its channels, even more than the volume of finance. Fortunately, efforts to make good use of finance are increasing within the context of growth strategies. The Tokyo Financial Center vision and local revitalization through local finance are some concrete examples of these efforts. Going forward, we must keep an appropriate distance from finance in order to use it to achieve economic growth, while fully being aware of the persistent possibility of unanticipated shocks arising in the market.

December 25, 2015
  1. ^ The accumulation of experience has made it easier to conduct quantitative assessments of quantitative easing policy, which used to have a strong "experimental" tone even in the area of the monetary policy. For example, efforts to assess it from this perspective are also on the rise in Japan, as observed in the analysis of Takeda and Yajima (2013).
  • Yosuke Takeda and Yasuhide Yajima. Hi-Dentoteki Kinyu Seisaku No Keizai Bunseki: Shisan Kakaku Kara Mita Koka No Kensho [Economic Analysis of Non-Conventional Monetary Policy: Verification of Effects from the Standpoint of Asset Prices] Nikkei Publishing Inc. (2013)
  • Davig, Troy and Refet S. Gürkaynak. "Is the Optimal Monetary Policy Always Optimal?" CEPR Discussion Paper 10767, 2015

January 19, 2016

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