Save Japan's economy from the "triple whammy".

Save Japan's economy from the "triple whammy".
Hidetomi Tanaka

Minor revisions to the manuscript that appeared in the May 2020 issue of SEIRON magazine.

The impact of the new coronavirus (COVID-19) on the Japanese and global economy is becoming more serious every day. The blow to the economy is on a scale equal to or greater than the Great Recession of 2009, with most experts predicting a major slowdown in the global economy. In particular, there is growing concern about the Japanese economy. The reason for this is that we are suffering from a serious "triple whammy economy".
 The "triple whammy" was the economic downturn against the backdrop of the U.S.-China trade war, the implementation of the consumption tax hike in the midst of that, and the impact of  COVID-19. More recently, the postponement of the Tokyo Olympics has added to this "triple whammy".
 Japan's economy began showing signs of slowing down in the fall of 2018 due to the U.S.-China trade war, and clearly entered a recessionary phase in 2019. Last October's 10% consumption tax hike was just the worst possible timing.
 The government, as usual, downplayed the negative effects of the consumption tax hike. They said the economic measures were "perfect" with the introduction of a reduced tax rate on daily necessities, point rebates, premium gift certificates, and a supplement to free education expenses to cover the consumption tax hike. The consumption tax hike, however, nearly nullified the government's response. The revised GDP growth rate for the October-December 2019 period has been revised downward to a 7.1% annualized decline, which is a true "total collapse of domestic demand".
 This is where a new type of coronavirus shock with immense uncertainty strikes. The root of the uncertainty of COVID-19 shock is not an economic event. Epidemiology is at the heart of it. Even the WHO and experts have no idea when the spread of the disease between Japan and the rest of the world will be contained. An exponential rise in the number of infected people is known as an "overshoot," and as of late March, major European countries such as Italy, France, and Germany have suffered from this phenomenon. The death toll has also increased significantly. The United States, the United Kingdom, Canada and South Asian countries are also experiencing a wave of infection spread. In China, the origin of the disease, there is a lot of talk about the containment of the infection, but any reasonable person would have dismissed it as political propaganda from the Chinese Communist government. The Japanese government also warned of the possibility of an "overshoot" at the March 19 press conference of the experts' meeting, although the infection is relatively well controlled at this stage. It will still take time to develop an effective treatment or vaccine. In short, unless the epidemiological problems are resolved, the uncertainties that lead to the economic crisis will not be dispelled. This uncertainty has the same meaning as the "fundamental uncertainty" pointed out by Boyee(2020).
I would like to examine the scale of the current economic crisis with a representative economic forecast that is available in the current situation. According to the Organization for Economic Cooperation and Development (OECD) basic scenario, the global economy will slow to 2.4% in 2020 from the previous growth rate of 2.9%, and the Japanese economy will decline from 0.6% to 0.2%. This is a case where the economic shock from the new coronavirus will end by the first quarter of 2020 (January-March). It is clear that this basic scenario has already failed, and the OECD has proposed an even more serious scenario: the domino scenario. This is a case of a prolonged global economic downturn due to shrinking aggregate demand in key countries in the Northern Hemisphere and the Pacific Rim, in addition to a global supply chain breakdown starting in China. Specifically, the damage to production and consumption caused by the COVID-19 shock will continue through the third quarter (July-September 2020). At this time, economic growth would fall to 1.5% in a domino scenario. The predictions of Nouriel Roubini, a professor at the University of New York, who has the nickname of "Dr. Doom," are at about the same level as this domino scenario. Simply put, the global economic growth rate will be cut in half or more. It would be about three times the impact of the basic scenario. Under the domino scenario, the Japanese economy would fall to about minus 0.6%.Dr. Doom also predicted a recession in Japan and Italy. Dr. Doom seems to be showing even more doomed prophecies on twitter and elsewhere these days. A recession in Japan would be a case of two consecutive quarters of economic recession, which is now being taken for granted. No, it's also possible that their predictions are naive. At best, the domino scenario will only have the same impact as the Greek crisis of 2011.
As I emphasize many times, the fundamental uncertainty of COVID-19 is so great that it is undeniable that it could be a major stagnation from 2009 or worse. At that time, the entire world economy would fall into negative growth, and Japan, with its "triple whammy" economy, would go even deeper, with low growth well above 1%. This is the real Great Depression for Japan and the world.
 It remains to be seen whether we will face the Great Depression or not. There is a way to tell if the domino scenario is in full swing and will lead to a further Great Depression.
  The first thing to do is to look at the "five conditions for risk-off" raised by Bank of Japan policy maker Seiji Adachi. Risk-off means a reluctance on the part of corporate executives and investors to act economically. The opposite is risk-on. In order for the economy to develop successfully, it is necessary to take risks and invest in ambitious businesses. If this were to wane at all, the engine of capitalism would be chilled.
(1) Sharp decline in stock prices
(2) A sharp drop in the yield on government bonds (especially U.S. bonds with high international creditworthiness)
(3) The rise in the price of gold, which has the character of  "flight-to-safety”
(4) A sharp rise in volatility indices such as the "VIX Index
(5) The appreciation of the yen and the appreciation of the Swiss franc
 is the five conditions for risk-off as proposed by Seiji Adachi.
 Let's take a look at the current status of the five items. New York's Dow Jones average fell continuously from Feb. 24-28, the first weekly decline of more than 12 percent since the Lehman shock. After that, the price continued to fluctuate and finally fell below the $20,000 level, down more than 33% from the level before the COVID-19 shock. The Nikkei 225 and other national stock indices have also experienced sharp declines. The Nikkei 225 is still down more than 30% in the year to March 18. The speed of the stock market's decline and the breadth of its collapse is comparable to the subprime mortgage crisis of 2008.
The yield on the 10-year U.S. Treasuries fell sharply below 0.5% for the first time in history. That's how much of a risk-off mentality has permeated the market. However, yields on US Treasuries rose sharply as the US government launched a major fiscal policy that focused on cash payments and the Fed's ultra-easy monetary policy to support this policy. This is also a sign that the market is calming down.
But on the other hand, the price of gold, which is supposed to be  "flight-to-safety" has fallen. The yen's weakening trend is also evident. These are not considered to be risk-off phenomena in the Adachi Five Conditions. But this time it was different. This is because the rapidly deteriorating economic situation has led to a growing global shortage of liquidity, or in short, money. In the U.S., in particular, the shortage of money is accelerating, especially among business owners and investors. Gold and foreign currencies (yen, Swiss francs, etc.) won't meet the sudden demand for cash. This has accelerated the yen's weakness against the dollar. In normal times, that level has reached the low 110-yen range to the dollar, which would be good for getting out of deflation. However, in this time of emergency, this cannot be categorically celebrated. This is because it's evidence that the level of risk-off has risen to outrageous levels. Central banks in various countries are trying to work together to solve the dollar shortage.
The bizarre rise in risk-off can be seen in the VIX, also known as the "fear index," which shows the level of concern investors have about the future. The higher the number, the greater the "fear" of investing. The level of the fear index is already well above that of the subprime mortgage crisis.
And, as in the case of the subprime mortgage crisis , the focus going forward will be on whether or not the money shortage will cause the financial system to malfunction further. During the subprime mortgage crisis, investment banks such as Lehman Brothers failed, and the shock to the economy was multiplied many times over by the excessive leverage that these financial institutions engaged in (over-investment behavior in an attempt to earn large returns with little capital). As expected, that was the lesson of the time, and we don't see excessive leverage now. Nevertheless, there are always risky investments that create bubbles and bursting bubbles. There is such a movement in some corporate bond markets right now. The bonds issued by U.S. shale oil companies, for example, are a prime example. The slowdown in the global economy, the breakdown of the OPEC-plus negotiations, and the subsequent strategy of Saudi Arabia and Russia to increase oil production have caused oil futures prices to fall significantly. This is said to have put the management of shale companies in a crisis. The U.S. high-yield bond spread, which represents the gap (spread) between these companies' corporate bonds and the yield on U.S. Treasuries, is widening rapidly. This may mean that a "bubble burst" is occurring in some corporate bond markets. If this is triggered and the financial system is destabilized from the collapse of the corporate bond market, we will have another subprime mortgage crisis. In order to avoid this, the Fed is trying to defend itself by aggressively supplying funds. In the face of an extraordinary risk-off, whether the money shortage (liquidity risk) is accompanied by a crisis in the financial system (credit risk) or not, there is a threshold at which the current economic crisis will be comparable to or exceed the subprime mortgage crisis.
 If liquidity risk is combined with credit risk, and this leads to a deterioration in the real economy, such as production and employment, the global economy will sink at an unprecedented level.
 In summary, at this stage, the acute shortage of money (liquidity risk) has outpaced the subprime mortgage crisis, but on the other hand, the impact on credit risk and the real economy is still minor. Most recently, however, the worsening of employment indicators in the U.S. economy has been noticeable. It depends on the response of each country's economic policies, but it is reasonable to think of it as within the OECD's domino scenario. The new Great Depression has not yet begun.
 What policies should Japan adopt in the face of such a "risk-off storm"? The answer is to use all available policies.
 The point of total policy mobilization is quantity and speed.As Professor Emeritus Koichi Hamada of Yale University pointed out in his article "The financial fight against COVID-19", fiscal policy comes into play when there is a need for urgency. To put it more simply, the government should support a cash grant if the people are rapidly running out of money. There is no reason to do nothing about monetary policy at this time. An aggressive accommodative stance is important in order to finance fiscal policy. The following statement by Bank of Japan Deputy Governor Masazumi Wakatabe is correct about the coordination between fiscal policy (the government) and monetary policy (the Bank of Japan).
“We believe that the Bank's flexible management of fiscal policy in response to economic conditions, with the Bank continuing its large-scale monetary easing, will enhance the synergistic effects of monetary easing and fiscal stimulus and make the economic stimulus effect stronger. In general, when the government increases government spending by increasing government bonds, it puts upward pressure on longer market interest rates, which in turn acts as a mechanism to gradually discourage private investment. In contrast, if the central bank restrains the increase in market interest rates even under the expansion of government spending, the negative impact on private investment, etc. will be limited and the economic stimulus effect can be expected to intensify." (Masumi Wakatabe, "Recent Monetary and Economic Developments and Monetary Policy Management," 2020.02.05)

 So how much of the money shortage in the Japanese economy should the government and the Bank of Japan work together to solve? In economics textbooks, there is a method called Keynesian cross diagram. The idea is to focus on the gap between potential GDP and actual GDP and to "fill in" the gap through fiscal policy and other means. potential GDP is an image of a situation where people who want to work have found most of the job openings and factories are running at full capacity. Using the Bank of Japan's estimates, Japan's current potential GDP is estimated to be about 525 trillion yen. Technicals should also be aware that there is some range in the estimates. As a result of the consumption tax hike during the economic downturn, the GDP gap has become almost zero. In addition, the COVID-19 shock strikes. Using the domino scenario, actual GDP will fall to about 519 trillion yen. Since the actual GDP of the Japanese economy before the consumption tax hike is 530 trillion yen, the GDP gap is a gap of minus 11 trillion yen. However, the 530 trillion yen at the time itself was at the time of the economic downturn. Pushing the economy back to cruising speed, at least before the downturn begins, is essential to get out of the "triple whammy" economy. If we assume that this level is over 535 trillion yen, the gap from the 519 trillion yen in the domino scenario is approximately over 16 trillion yen. Already about 4 trillion yen has been spent in the supplementary budget and reserves earlier this year. Subtracting them together, the GDP gap is about 12 trillion yen. This needs to be "filled" with fiscal policy. This is the part that will be filled with so-called "fresh water" such as new bond issues. It has been reported that the ruling party has proposed a 60 trillion yen project scale, but it is only this "fresh water" part that will actually boost the economy. "Fresh water" includes public utilities, tax cuts, fiexed benefits, etc.

 The key to the policy response this time around, I'll write again, is quantity and speed. We now know that the amount needs to be at least 12 trillion yen. However, this will also increase depending on future economic conditions. The mainstay in terms of speed is the fixed benefit. It is a policy of handing over cash as-is to individuals and sole proprietors who are short of money. However, this is not enough to save Japan's economy from the "triple whammy". We have to deal with the economic downturn caused by the consumption tax hike. To do so, we simply need a consumption tax cut. And while fixed benefits and the like are an excellent emergency response, this consumption tax cut would be an excellent response even if the economic downturn from  COVID-19 shock is prolonged.
 Of course, there are a variety of policy options beyond fixed benefits and consumption tax cuts. However, there is a caveat. There are political forces and bureaucracies pushing for austerity even in this economic crisis. Treasury's presence. A policy scheme like the one favored by the Treasury would undermine fiscal policy. The Treasury wants to squeeze out as much government spending as possible. The limited, fixed benefits the government is now considering would total up to about 3 trillion yen. This is far too small a scale compared to the total amount of 100,000 yen in fixed benefits per capita.Such austerity measures are probably the brainchild of the Treasury and the Treasury-inspired politicians.

The policy measures are diverse, including a refund of the consumption tax, exemptions from property taxes, social insurance premiums, utility bills, and communication costs, and an expansion of the employment adjustment fund. I will narrow the discussion here to just fixed benefits and consumption tax cuts.
 If we give out 100,000 yen per capita in fixed benefits and cut the consumption tax (or reduced tax rates on all items) by 8%, the scale of fiscal policy would be about 16-17 trillion yen. Based on this, we should consider the possibility of a super increase in the amount depending on the situation.
 The counterargument is that when fixed benefits were made in the past, only about 30% were consumed and the rest went to savings. This is the wrong argument on three counts: 1) there is no better way to immediately distribute the money to low-income earners and businesses with serious money shortages than with cash payments; 2) the money could be used to save money, rather than helping to alleviate future fears; and 3) the money could be distributed as coupons with a fixed term. However, there is a weakness in that it takes time to prepare the coupons.
 In addition, there are those who oppose the consumption tax cuts, pointing to a "rush to cut back on consumption" just before the tax cuts. This is a silly argument. If you bring up this rationale, you won't be able to cut consumption taxes forever. The contribution of fixed benefits or even an aggressive monetary policy could weaken this "reactionary decline". Another idea is to set the expiration date of the earlier expired coupons to the day before the consumption tax cut. In other words, the "rush down" is counteracted by the "rush up" of coupons.
 There are also plenty of ideas for expanding monetary policy. First of all, the government should expand its quantitative easing policy (increasing purchases of long-term government bonds and other assets up to 100 trillion yen per year), purchase management resources from financial institutions, expand purchases of ETFs and J-REITs, strengthen its commitment to the inflation target, and purchase of foreign bonds with the approval of governments, especially the United States, in terms of the international political game. However, this measure may be difficult to adopt when there are concerns about a shortage of dollar funds.
 There are a wide variety of policy options. The country's ups and downs will depend on its political decisions and public support, whether or not it adapts to the economic crisis with the right amount and speed.



Boyer ,Robert(2020) Cette crise inédite adresse un redoutable avertissement aux économistes ;