Thursday, July 6, 2017

Demographics - The Central Bankers' Nightmare

Updated January 2018

In 2017, former Federal Reserve Chairman, Ben Bernanke, gave a pep talk to the Bank of Japan, discussing the nation's monetary woes.  As those of us that have been paying attention know, Japan's economy has suffered from a multi-decade period of mediocrity with deflationary pressures present despite the Bank of Japan's best efforts to stimulate inflation and reverse low economic growth rates.  In this posting, I want to look at some of his key points and explain why I think that the Bank of Japan, like the Federal Reserve, is doomed to monetary policy failure.  

Let's open by looking at two graphics; one showing the population pyramid for Japan, a graphic which shows the age distribution issues facing Japan:

As you can see, there is clearly a dearth of younger Japanese supporting an aging population, an issue that is causing significant problems for the nation's economy.

Here is a current population pyramid for the United States:

While that doesn't look particularly threatening, here is a projected population pyramid for the United States in 2056:

As you can see, in four decades, the situation has changed significantly with the U.S. pyramid starting to resemble the bottom-light pyramid of Japan, although, not quite as bad thanks to a higher birthrate among some people groups in the United States.  The further out that we go, the worse the situation looks with fewer and fewer young Americans supporting more and more older Americans, in large part because of the dropping birth rate as shown here:

Now, let's start the main part of this posting by looking at what the Bank of Japan has done to stimulate its economy:

As you can see, the Bank of Japan has had an extended period of near-zero interest rates going all the way back to  the mid 1990s.

Now, let's look at what Ben Bernanke recommended for the Bank of Japan in the early years of the new millennium, prior to his term at the helm of the Federal Reserve and while he was still an academic:

"I argued that central bank purchase programs should focus on longer-term assets and not be concentrated on bills (i.e shorter term government securities), as had been Japanese practice in earlier forays into quantitative easing.  I made the point, associated with Reifschneider and Williams (2000), that in the face of deflation risks it was important not to try to conserve policy ammunition but to move “decisively and preemptively” (Bernanke, 2002). I emphasized the need to set an inflation target high enough to provide some buffer against deflation, and I noted that temporary overshoots of the target to compensate for prior inflation shortfalls could be warranted following a period in which rates are constrained by the effective lower bound.  I frequently acknowledged the need to complement monetary policy with fiscal and structural measures and cited the critical importance of assuring financial stability through lender-of-last resort actions, financial regulatory reform, and bank recapitalization."

Here's what he had to say in hindsight about his recommendations:

"However, I certainly did not get it all right. In particular, in earlier writings I was too optimistic and too certain about the ease with which a determined central bank could conquer deflation, and I had little patience with the alternative view. For example, in a 2000 paper written while I was still an academic, I criticized the Bank of Japan for its “self-induced paralysis” and for showing insufficient “Rooseveltian resolve.” I asserted that more-aggressive policies would certainly yield better results, as Franklin Roosevelt’s unorthodox strategies seemed to do in 1933, and, indeed, as Minister Takahashi Korekiyo’s policies did in Japan during the same period. But when I found myself in the role of Fed chairman, confronted by the heavy responsibilities and uncertainties that came with that office, I regretted the tone of some of my earlier comments. Central banks do have viable options at the effective lower bound, but the problem has proved less tractable, in both the United States and Japan, than I had suggested. In particular, in some of my early writings, I did not always demarcate sharply enough between what monetary policy can achieve on its own, and what requires some degree of coordination with fiscal policy (i.e government-led stimulus spending).  At a 2011 press conference, in response to a question from a Japanese reporter about my earlier views, I responded, “I’m a little bit more sympathetic to central bankers now than I was ten years ago.” Why ending deflation and escaping the effective lower bound has proved tougher than I once expected will be one of the themes of my talk today."

His conclusions about the Bank of Japan and what should happen on a going-forward basis?

1.) The Bank of Japan should continue to pursue its goal of 2 percent inflation because it will restore economic stability in the future by restoring the ability of monetary policy to respond to future economic contractions.

2.) Since 2013 and the election of Shinzo Abe, the Bank of Japan's policy of quantitative and qualitative easing (QQE) has been implemented policies which, interestingly, included purchases of exchange-traded funds (i.e. the stock market) and private assets, the Bank of Japan's balance sheet has grown to about 88 percent of Japan's GDP at the end of 2016 compared to 24 percent for the Federal Reserve and 34 percent for Europe's ECB.  While this has had some benefits to the Japanese economy, it is unclear whether the Bank of Japan will actually be able to meet its objectives since much of the economic response "...depends in part on factors outside of the central bank's controls".

3.) If (and it appears that the Bank of Japan has already passed the point of no return on their policies) current policies are insufficient, Japan needs a program of both fiscal and monetary co-operation in which the Bank agrees to increase its inflation target temporarily to offset increased government spending or tax cuts to prevent the nation's debt-to-GDP from rising any further.  Since Japan's debt to GDP is already well passed the danger zone at more than 200 percent of GDP, this could prove to be problematic.

One significant issue facing the Bank of Japan is its massive balance sheet.  Here is a table showing the massive size of the Bank's assets:

Using a conversion rate of 111 Yen to the U.S. dollar, the Bank has a balance sheet totalling $4.54 trillion (U.S. dollars) with 85.5 percent of that being Japanese government securities as shown on this graphic:

While this is only slightly higher than the Federal Reserve's current balance sheet in dollar terms, it is a far higher percentage of the entire Japanese economy as shown here:

While we (and I included Mr. Bernanke in the collective), may think that the Bank of Japan's struggle to right Japan's sinking economic ship may be a unique situation, as the population pyramids at the beginning of this posting show, the demographic changes facing the United States and the other developed economies of the world mimic (in large part) those of Japan.  While Mr. Bernanke may be full of ideas on how the Bank of Japan should handle Japan's economy on a going-forward basis, demographics are proving to be a central bankers' nightmare and no amount of monetary policy creativity will be able to reverse the structural changes in the world's developed economies that are associated with an aging population and lower birth rates.  

No comments:

Post a Comment