Robert M. La Follette School of Public Affairs
Friday, June 21, 2013

Economists see value in Japan's new monetary policy

Menzie Chinn

Isao Kamata

Available online

Can Japan Export Its Way to Recovery?
Spring-Summer 2013 La Follette Policy Report

The United States and other countries should welcome Japan's unconventional decision to increase inflation as a method for growing its economy growth, economists Menzie Chinn and Isao Kamata argue in a new analysis from the La Follette School of Public Affairs.

The two professors discuss Japan's policies to raise inflation from zero to 2 percent and to drive down interest rates by having the Bank of Japan purchase government bonds and other assets in the latest issue of the La Follette Policy Report.

Both moves can help Japan increase its economic growth. "Each measure reduces borrowing costs in inflation adjusted terms and loosens credit constraints on firms and households," Chinn says, adding that he and Kamata also expect the value of the yen to drop as expectations of inflation rise.

For the United States, the question is whether the policies will affect Japan's gross domestic product. "As the yen loses value, exports become cheaper for people outside Japan," Chinn says, "and imports become more expensive. Greater exports means more economic growth for Japan, and hence for the world economy."

However, Kamata notes, a large portion of Japan's imports are commodity-based, included oil and natural gas, which are priced in U.S. dollars. With the yen's value at a lower level, the cost of these fuels would increase for Japan.

Overall, Chinn and Kamata say, a simulation of Japan's economy suggests that a 20 percent depreciation of the yen's value could increase the country's gross domestic product by around 1.6 percentage points.

Their analysis is based on historical relationships that may not continue. "Japan's export industries have changed dramatically since the country increased offshore production in the mid 1990s," Kamata says. "Japan has become inextricably integrated into the East Asia production chain. As a consequence, higher exports require more imports of the components needed for manufacturing." More expensive imports may offset part of the economic growth due to more exporting, he adds.

Japan also might do well to expand government spending, cut taxes or increase government payments to individuals, Chinn and Kamata say, but the path of a looser monetary policy with the resulting exchange rate depreciation and inflation should help revive Japan's economy.