|Prime minister Shinzo Abe became a late convert to the Yale University professors monetary recipe for ending Japans deflation and weakening the yen.|
How important are the supply-side reforms in Abes third arrow?Once the monetary initiative reaches its success point of near-full employment, it can only increase the price level, so we have to have policy for the real economy. Thats why the third arrow is important. It is like potential growth. Japans potential or capacity growth was hit by the 2011 great east Japan earthquake, but the rate is probably between 1% and 2%. Right now the economy is increasing at 4% or so because it is in the process of approaching the full employment level capacity growth. To increase the capacity growth path there is not much that can be done. You cannot invite technical progress down from heaven. What I think should be done is not to ask what the government can do, but to ask what the government can undo: its regulations and controls. So there are proposals for deregulation, freer trade and reductions in corporate taxes. In employment and the labour market, in agriculture, in the medical industry, there are many fields where deregulation would work. So the third arrow may work by undoing government controls. How strong is the bureaucratic resistance to Abes policies? The deregulation drive started under [former prime minister Junichiro] Koizumi and [his cabinet minister Heizo] Takenaka. It requires bureaucrats to shed their armour and to disarm. It is a painful and difficult process, because structural reform in the public sector literally means the public sector should lose some of its authority and power. Prime minister Abe now has stable majorities in both houses of the Diet, but does he have the will to take on the bureaucracy? He has the will. Dont forget the Bank of Japan objected strongly to the easy-money policy, but Abe-san had the courage to adopt it; and, in spite of resistance from many sectors, he managed to join the Trans-Pacific Partnership. The TPP has many aspects and I am not fully happy with some of the demands from the US on the rules of the game, but there are good parts to it, such as making farming more competitive, even turning it into a Japanese export industry, at least the modern part of Japanese agriculture, if not rice production. So Abe-san showed courage. But whether he can stand up to all the pressure from the bureaucracy remains to be seen. He will face a lot of obstacles. But it is difficult to find any other leader who can at least think independently of the ministry of finance, or as it was until recently, the Bank of Japan. In the first arrow of monetary policy, you appear to have succeeded in changing the expectations of the Japanese about price increases, but what about the money supply? High-powered money or the monetary base can be manipulated by the central bank, but it is difficult to increase the money supply. One way to break the ice was through expectations, and it is now invigorating the stock market, the labour market and also invigorating the commercial loan market and so forth, through inflationary expectations and the exchange rate change. Because of this long deflationary period of 15 years or more, there was a real liquidity trap; the way to escape from it was through changing peoples expectations. Its now working, so after inflation returns to a certain percentage, more normal working of monetary policy will be possible. Also, there are various channels available to us. More investments are profitable because you can sell the new issues of stock more easily. If you have a higher value of financial assets, it will help to raise collateral for lending and borrowing and will unlock the commercial loan market. Such things are gradually taking place, and I am very happy and optimistic about the future of the first arrow. But how fast it works, or how strong it works, and how soon it hits some kind of grey inflationary zone is unknown. We have to be very careful that this policy does not ignite genuine inflation itself.
He is very serious about defending Japanese citizens. He is very honest and sincere in his anger against the aggression of North Korea towards Japanese citizens, or against some Chinese excessive claims. So Japan should be not only a beautiful country, but also a strong country able to defend itself. At the same time, I hope, this normalization shouldnt entail suppressing personal freedoms for which many advanced nations have fought long and hard. My friends in the US are worried that amendment of the constitution will lead to such extremes. I dont know. I havent had time to talk about politics, even diplomacy, with the Japanese prime minister, but I can tell that he is very cautious recently of the effect of his expressions on diplomatic issues.