The new administration of Japanese Prime Minister Shinzo
Abe has introduced a three-pronged approach to stimulating
growth in Japan. The components of the plan include
increased fiscal stimulus through public works, growth strategies
aimed at reinforcing private investment, and an aggressive
increase in monetary stimulus through unconventional
The third element of Abe’s program has generated substantial
controversy in international policy circles. Two measures
promoted by Abe’s choice as governor of the Bank of Japan,
Haruhiko Kuroda, potentially have major international repercussions.
Kuroda is committed to raising the rate of inflation
from zero to 2 percent and driving down longer term interest
rates by purchasing government bonds and other assets.
Although government officials have stressed they would not
directly intervene in foreign exchange markets to weaken the
yen, expansionary monetary policy will inevitably lead to considerable
depreciation of the yen, which should spur exports
and, therefore, increase economic growth.
In this note, we assess the rationale for Kuroda’s aggressive
action, the prospects for success along the international dimension,
and potential hazards to the Japanese economy.
We use some of the back-of-the-envelope estimates of trade elasticities reported in this post to assess how much of a gain to via trade flows will occur given the yen depreciation to date. Figure 1 shows the Japanese trade balance to GDP ratio.
Figure 1: Japan trade balance to GDP ratio (blue), and ex-fuel imports (red).
With the yen about 20 percent weaker than in the third
quarter of 2012, should one expect the Japanese trade balance
to improve sufficiently to affect output? Estimates published
in 2007 concluded that imports are relatively insensitive to
price changes, while each 10 percent change in the inflationadjusted
value of the yen induces a 3.4 percent increase in real
exports. 2012 estimates suggest the impact is slightly larger,
4.4 percent to 6.1percent. In our own estimates, we find that
Japanese exports will increase by about 5 percent in response to
such a drop. A sustained 20 percent depreciation, such as that experienced thus far, should result in an increase in real exports
equivalent to about 1.3 percent of GDP in the fourth quarter
of 2012. This means that after about a year, GDP should be
about that much higher. Of course, one can’t simply add the
1.3 percent to the level of Japanese GDP. Although the additional
exports suggest a boost to income, the resulting additional
income will generate an increased demand for imports,
offsetting some of this growth.
Update. Willem Thorbecke has some additional work on the subject of trade flows.