Two diametrically-opposed approaches to dealing with inflation – stupidity versus the Japanese way

Well things are going to get messier with the decision yesterday by the OPEC+ cartel to significantly reduce the oil supply and push up prices. On the one hand, when OPEC was first formed and pushed prices up, while there was significant disruption to oil-dependent nations, the substitution that followed (home oil heating abandoned, larger cars replaced by smaller cars, etc) was ultimately beneficial. So given that we need less cars on roads and less kms travelled by cars, one might consider the move to be fine. But given the way the central banks and treasury departments around the world are behaving at present, the short term impacts of the OPEC+ decision will be very damaging. How citizens endure whatever extra inflationary pressures that might emerge will depend on the fiscal and monetary policy responses. We have two diametrically opposed models: the one that most nations are following (hikes and austerity) versus the Japanese approach. I explain the difference below and predict that the latter will deliver much better outcomes for the people.

OPEC supply cuts

The plus in OPEC is the non-OPEC oil producing countries, including Russia, who agreed to go along with supply cuts in 2016 proposed by the 13 OPEC nations.

According to the – Oil Market Report – September 2022 – published by the International Energy Agency (IEA), Russian oil production is expected to decline further by the end of this year and the EU embargo binds.

However, even with that reduction, the IEA estimates that:

Such losses would still leave the market oversupplied in 2H22, by close to 1 mb/d, and roughly balanced in 2023.

The IEA also estimates that the OPEC 13 countries have spare crude oil production capacity of around 2.75 million barrels per day, while OPEC+ nations have spare capacity of 0.51 million barrels per day.

So the decision to cut production by 2 million barrels a day is not quite the squeeze that the sensationalist headlines are suggesting.

The cuts are in the context of an already oversupplied market.

How much prices rise is a guess at this stage and any price rise will of course help Russia, which is facing significant cuts in volumes sold.

Whether we can interpret that as OPEC ditching the US and cosying up to Russia as a new ally is the domain of propaganda.

It looks to me rather a decision based on price ambitions rather than some strategic geo-political switch by the main oil producing nations.

OPEC is seeing the madness of central bankers trying to drive their economies into recession as fast as they can and knows that in a state of (already) oversupply, a recession will worsen the excess and drive prices below what they want to receive.

The purpose of a cartel is to control prices to achieve income aspirations.

And with the EU and the US now colluding to set price caps, it has become one ‘cartel’ (informal) on the demand side against another cartel (OPEC) on the supply-side.

We should not be surprised therefore for the supply-side to rule.

But if the OPEC logic that higher interest rates have forced their hand is accurate, then we have the beginnings of a sort of vicious cycle:

Oil supply withdrawal -> Oil price hikes -> Higher inflation rates -> Higher interest rates -> More supply withdrawal.

And so it goes.

That will be a very ugly short-term outcome if it occurs.

But the IEA September oil market report tells us that many of the OPEC members are not producing anywhere near their targets (and have excess capacity), so the price impacts of the decision to withdraw supply may be rather small.

To some extent, it will depend on whether China abandons its (excellent) zero Covid strategy.

At present, that is keeping the oil demand side more muted than otherwise.

Overall, the concentration on energy issues at present are focusing our minds on shifting away from fossil fuels, which over time will be an excellent outcome.

In the short-term, the inflationary impacts so far arising from the OPEC decisions (as well as other sources – Covid, War in Ukraine) – have invoked mostly harsh contractionary fiscal and monetary policy responses.

When I say contractionary monetary policy responses, I am referring to the mainstream logic that says rising interest rates are counter-inflationary.

We know there is evidence to support the contrary hypothesis.

But one country stands out from the rest in this regard.

It is the country I am currently working in and studying closely.

Fiscal and monetary policy comparisons

The following graph shows the movement in fiscal balances as a per cent of GDP for selected advanced nations and the Eurozone in total from 2013 to 2022.

The country designations are in order of where the fiscal balance is currently estimated to be sitting (not enough space to align them next to the relevant lines but you can trace the lines relative to nations easy enough).

The Eurozone Member States as a whole (dominated by Germany) shifted the least during the pandemic and the degree of fiscal support provided was significantly different to the English-speaking west.

The UK and US swung the most during the pandemic but the degree of fiscal contraction since 2020 has been substantial.

The standout is Japan at the other end of the scale – its fiscal balance did not fluctuate as much during the pandemic as say the US and the UK, but it has held its fiscal support at around 8 per cent of GDP to the current period, in contradistinction to the other nations.

The other standout in Japan’s case is the conduct of the Bank of Japan which maintains a minus 0.1 policy target interest rate.

It also continues to purchase large quantities of Japanese government bonds.

Consider these facts:

1. Since December 2012 (when Shinzo Abe took office), the Bank of Japan has purchase 165.9 per cent of the total bonds outstanding.

That means it has bought all the new issues and then some.

2. Since the pandemic began, the Bank of Japan has purchased 41 per cent of the change in outstanding government debt, more or less maintaining its overall proportionate holdings.

The following graph shows the Bank of Japan’s holdings of government debt since 1990.

Japanese exceptionalism

Japan has faced the same global supply pressures that have pushed the current inflationary impulse.

But while other nations are busily engaging in fiscal austerity in the misconceived need to ‘repair their budgets after the pandemic’ and their central banks are hiking like crazy, Japan has held its nerve with respect to interest rates and has been particularly active in using fiscal policy to reduce the cost-of-living pressures on ordinrary Japanese citizens.

A world away in other words from elsewhere.

I wrote about that a few months ago – Why has Japan avoided the rising inflation – a more solidaristic approach helps (July 4, 2022).

On Monday (October 3, 2022) the Prime Minister Mr Kishida, with his face mask responsibly on in an indoor setting, announced in the new (210th) Diet (Parliament) that the government would introduce what he termed “unprecedented and drastic measures” to address inflationary pressures, including policies to reduce electricity bills for both households and businesses.

What, fiscal austerity or pressuring the Bank of Japan to push up interest rates?

Quite the opposite.

The Government will launch a series of fiscal spending initiatives this month.

You can find the full transcript of his speech here – 第二百十回国会における岸田内閣総理大臣所信表明演説 (Policy Speech by Prime Minister Kishida at the 210th Session of the Diet).

The PM told the DIET (my translation):

1. “We will do everything in our power to respond to the current high prices and revitalize the Japanese economy”.

2. “The Covid crisis, the energy and food crisis, and the climate crisis caused by global warming have plagued the world for the last two and a half years.”

3. “Japan has overcome the corona disaster and normalization of socioeconomic activities is progressing. However, Russia’s aggression against Ukraine, soaring energy and food prices due to the yen’s depreciation, and fears of a global economic recession have become major risk factors for the Japanese economy.”

4. “Last month, we finalised additional measures to curb rising food and gasoline prices. We have taken urgent support measures, especially for low-income households whose financial impact is particularly large.”

5. “we will design comprehensive economic measures this month, and will do whatever it takes to protect people’s lives and business activities from these high prices.”

6. “measures have already been taken to keep the import wheat prices … unchanged from October onwards.”

7. “A major issue … is the risk of a sharp rise in electricity prices. We will take unprecedented and drastic measures that will directly reduce the rising cost of electricity for households and businesses.”

And more.

You get the drift.

He also spoke of managed wage increases within the public and private sectors to deal with the historical problem of low wages growth and investments to raise productivity and economic growth.

Compare that narrative with what we hear from the English-speaking leaders – ‘budget repair’, ‘heaving from trillion dollars of debt’, ‘fiscal policy has to be restrained so interest rates don’t keep rising higher’, ‘interest rates will rise until we stop inflation’, etc.

Light years apart.

You can also find the documents relating to these new measures at the Cabinet Office site – HERE (released October 5, 2022 and written in Japanese).

The Prime Minister noted that:

Today, we discussed the formulation of comprehensive economic measures and related investment in people and GX (Green Transformation). In order to put the economic measures on a high growth path, first of all, we will take all possible measures to support people who are in a difficult situation due to soaring prices. In addition, in order to achieve continuous wage increases that will not be outdone by price increases, we will strengthen support for reskilling to move to growth areas and support for small and medium-sized enterprises in light of the minimum wage hike from October. At the same time, under the new capitalism, we will accelerate public investment, which will serve as a prime mover in priority areas, and further expand private sector investment.

Already, we have seen the Japanese government pay subsidies to petrol wholesalers which has kept petrol prices much lower than otherwise.

While the full detail is yet to be announced, it is likely they will use the same approach for energy suppliers.

Conclusion

It is very interesting living and working in Japan at present and seeing these policies close up.

Coming from Australia, where the RBA has been damaging the prospects of low income home owners and would-be home owners after promising they would not raise interest rates until 2024 and listening to the Treasurer bat on, on a daily basis, how we must tighten our belts and have a national conversation about how we will pay for things, Japan is like a breath of fresh air.

They talk about protecting the citizens and using the currency-issuing capacity of the Japanese Ministry of Finance and Bank of Japan (consolidated) to do whatever it takes to protect them against inflation, while the supply constraints take their time to work through.

An amazing difference.

And Modern Monetary Theory (MMT) will tell you which approach will deliver better outcomes for the well-being of the people.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.