Joshua K. Hausman and Johannes F. Wieland presented a paper today on Abenomics at the Brookings Panel on Economic Activity. They focus specifically on the monetary policy portion of Abenomics: the Bank of Japan's new commitment to 2% inflation, open-ended asset purchases, and a doubling of the monetary base. Abenomics is frequently covered on this blog and these authors reach similar conclusions:
We show that Abenomics ended deflation in 2013 and raised long-run inflation expectations. Our estimates suggest that Abenomics also raised 2013 output growth by 0.9 to 1.7 percentage points. Monetary policy alone accounted for up to a percentage point of growth, largely through positive effects on consumption.
They see Abenomics' success coming from its commitment to a new monetary regime, one that credibly moves Japan away from its deflationary past. Like others, they compare Abenomics to FDR's regime change in 1933, but acknowledge it has not proportionally packed as much of a punch. The authors attribute this difference to the relatively small size of Abenomics as well as the Bank of Japan lacking full credibility on its new inflation target. They see the lack of full credibility as a consequence of its monetary history and demographics (i.e. pensioners hate inflation).
This paper largely fits my priors. However, I do want to comment on a key difference in our views. The authors take a New Keynesian view on how Abenomics works. They see it working by raising expected inflation and lowering the real interest rate. My view is that Abenomics works because it has committed to a permanent expansion of the monetary base which, in turn, has implications for the future price level and future nominal incomes. Here is how I recently made this point in the context of a NGDP level target operating in a slump:
[NGDP level targeting] would create an expectation that some portion of the monetary base growth from the asset purchases would be permanent (and non-sterilized by IOER). That, in turn, would mean a permanently higher price level and nominal income in the future. Such knowledge would cause current investors to rebalance their portfolios away from highly liquid, low-yielding assets towards less liquid, higher yielding assets. The portfolio rebalancing, in turn, would raise asset prices, lower risk premiums, increase financial intermediation, spur more investment spending, and ultimately catalyze a robust recovery in aggregate demand.
While our views may be complimentary, I do think something is lost by focusing too narrowly on the New Keynesian channel. The portfolio rebalancing process I outline above is effectively the same thing as a reduction in the excess demand for money. And excess money demand--broadly defined to include both retail and institutional money assets--in my view is the deeper reason for the slump of the past five years. A permanent, unsterilized injection of the monetary base would have gone a long way in solving this problem.
The Fed has always said its asset purchases are temporary and the public has bought into this view. Consequently, the Fed's QE programs have not been as effective as they otherwise could be. Here is a figure from an earlier post that makes this point:
Although Hausman and Wieland's credibility discussion alludes to this issue, I wish they had directly discussed the issue of a permanent versus temporary increase in the monetary base . Michael Woodford has stressed this point too. So has Alan Auerback and Maurice Obstfeldt. They formally demonstrate the importance of a permanent monetary base increase in great AER paper that has unfortunately receive far too little attention in recent debates. Here is an excerpt (my bold):
Prevalent thinking about liquidity traps, however, suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open-market operations in- effective as a stabilization tool...Yet, our analysis shows... that credibly permanent open- market operations will be beneficial as a stabilization tool as well, even when the economy is expected to remain mired in a liquidity trap for some time. That is, under the same conditions on interest rates that make open- market operations attractive for fiscal purposes, a monetary expansion that markets perceive to be permanent will affect prices and, in the absence of fully flexible prices, output as well...Our analysis suggests that Japanese policymakers should underscore the permanence of past operations, perhaps through an announced inflation target range including positive rates, and may need to increase the monetary base even more.
That last sentence is striking. It is call for Abenomics almost a decade before it was adopted. It would have been nice to seen a discussion of it in the Hausman and Wieland paper. Still, the paper overall is a good read and worth your time. Give it a look.
Addendum: Milton Friedman would probably be happy with Abenomics.