Topics: Inflation, Monetary policy, Macroeconomics Pages: 10 (2206 words) Published: March 6, 2015
1. Introduction

This essay will discuss on The Economist (2014). The article spoke about the economic policies Japan implemented, the intention and aftermath of it. It had covered the “three arrows” of which abenomics is based upon, namely fiscal stimulus, monetary easing and structural reforms, of which is executed to encourage private investments. Major points from the article will be explored in greater detail and a better comprehension will be derived on how the Japanese government intends to carry the country out of recession and achieve an objection of 2% core inflation rate of which the Bank of Japan (BOJ) had projected. At the end of this essay, with greater understanding of the purposes and intention of the implemented policies, a conclusion and opinion will be drawn.

2. Monetary easing - Monetary Policy

As cited by the Economist (2014),
“The scale of the central bank’s action – it will print money to buy 80 trillion yen of government bonds a year.”

Monetary easing as highlighted above by the Japanese government would suggest that they had adopted the expansionary monetary policy via the open market operation tool. This is further interpreted by Parkin (2014: 654) denoting that,

“The Federal Reserve’s (Fed’s) attempt to influence the economy by changing the interest rates and the quantity of money is called monetary policy.”

The act of purchasing Japan’s equities on an annual basis is to boost the money supply (MS) in the economy and increase the excess reserves of commercial banks for loans, henceforth addressing the ballooning public debt. Confronted with excess reserves growth, commercial banks would naturally reduce the interest rates for loans. BOJ (2005) states that it promises to sustain a zero rate commitment of which the policy rate will stay at zero until Japan’s economy is out of deflation. This is to encourage borrowing in an attempt to stimulate the economy through expenditure, production and exports.

Diagram 2.1 Japan GDP Growth Rate Chart

Diagram 2.1 depicts Japan is in the midst of a recession. As shown the GDP growth rate remains negative for two consecutive quarters, -1.9% in the second quarter and -0.5% in the third quarter of year 2014. This reflects that Japan is experiencing a recovering recessionary economy.

With reference to Parkin (2014: 497),
“A common definition of recession is a period during which real GDP decreases – its growth rate is negative – for at least two successive quarters.”

Diagram 2.2 Money Market Graph

As presented in diagram 2.2, a boost in money supply would result in a rightward movement of the MS curve, from MS1 to MS2 due to the increase in the quantity of money from Q1 to Q2 by 80 trillion yen. Even though the nominal interest rate is expected to reduce from R1 to R2, but in the situation of the Japan economy where there is a zero rate commitment environment, the nominal interest rate cannot decline any further.

Due to the zero interest rate, spending and borrowings are being stimulated, opposed to encouraging savings. This will result in both household consumption expenditure (C) and planned investment (I) to increase. Based on the subsequent equation stated below, an increase in any component contributes to a higher aggregate demand (AD). AD = C + I + G + X – M

Diagram 2.3 AS-AD Model for Expansionary Monetary Policy

As illustrated in the aggregate supply- aggregate demand (AS-AD) model above, when the AD curve shifts to the right from AD1 to AD2 when aggregated demand increases, the price level will increase from P1 to P2. When this occurs, the real GDP shifts from Q1 to QP, closing up the recessionary gap of Japan’s economy.

The Bank of Japan’s decision to print 80 trillion yen to purchase back government bond would result in the depreciation of the value of yen due to the flexible exchange rate. According to Parkin (2014: 630),

“A flexible exchange rate is an exchange rate that is determined by...

References: Japan GDP Growth Rate. (2014). [image]
[Accessed 26 Dec. 2014].
Japan Unemployment Rate. (2014). [image]
[Accessed 26 Dec. 2014].
Jiji, (2014). U.S. Treasury to Japan: Refire ‘three arrows’- including structural reform The Japan Times. [online] The Japan Times.
Kihara, L. and White, S. (2014). Japan’s Unemployment Rate Hits A 16-Year Low. [online] Business Insider.
[Accessed 26 Dec. 2014]
Manthorpe, J
Parkin, M. (2014). Economics. 11th edition. United States: Pearson Education
Riding to the rescue
Sharp, A. and Masaaki, I. (2014). Japan Real Wages Fall to Global Recession Low in Abe Risk (2). [online] Businessweek.com.
[Accessed 26 Dec. 2014].
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