The Effectiveness of Japanese Stimulus

David Bath in a question to this post asked about Japanese stimulus. “The package announced last week "mamizu" of ¥1.1 trillion, looks to lift the forecast for Japanese GDP growth in 2009 by around 1.1-1.3%. That is, it will improve growth from -3% in 2009 from the -4.3% expected before the package was announced.”

My response: I saw the monumental change in some forecasts for 2009 once the stimulus was announced. But, these must just be knee-jerk reactions to the stimulus that assume effective fiscal stimulus. I already knew I was in the minority on multipliers so these numbers don’t surprise. But, we can use these numbers to get assumed paths for GDP under effective stimulus and for my case. Then at the end of the year, once the data is in, we can compare and judge the effectiveness of this particular package.

Let’s think about what a reasonable path for Japanese GDP during 2009 might be and let’s think about when the stimulus might reasonably be expected to come online.
The stimulus is expected to be passed this month; given the slow pace of implementation with the previous two packages, I think mid-summer is an optimistic date for the actual spending to begin. So, all of the stimulus from this round must fall into the third and fourth quarters.

Pre-announcement, most analysts seemed to be thinking something like the following for Japanese GDP: -17% Q1; -4% Q2; -1% Q3; and between 0 and 2 for Q4. I am assuming from your 4.3 percent figure that you were expecting an average of positive two percent growth in both Q3 and Q4 at least if your forecast for the first half is similar to others. (All figures annual rate.)

Working from my assumption of your baseline, the stimulus would have to boost Japanese growth to 5.4 percent in both Q3 and Q4 to reach -3 percent growth in 2009. That’s a boost to GDP in the second half of 1.6 percent over the baseline. Assuming that half of the stimulus is spent this year (about 1 percent of GDP), the assumed multiplier is 1.6. This seems high to me.

But now we have a baseline of comparison. If the multiplier is large, we expect very fast GDP growth in the second half, something on the order of 5 percent. I expect that if the Japanese government does try and spend all 10 percent of the money they say they have allocated (they have not spent much yet), the second half will remain tepid. I would expect zero or negative growth in the second half. Two predictions, very different. Let’s wait and see what the numbers are later this year. Then we can do a retrospective on the effectiveness of this stimulus. We still won’t have the counterfactual but at least we have our forecasts.

Big positive growth numbers  more likely fiscal stimulus is effective
Zero or negative growth numbers  more likely that it is not

That’s the main question: Here are a few other misc. questions from his post (in italics).

Surely if there were limits to the overuse of consecutive stimuli and monetization we would be seeing it in Japan? Long term rates remain very low.

So, we don’t yet know what the limits in Japan are. While they have announced large packages, as you noted about 10% of GDP, only a tithe of this has been spent so far. And virtually nothing is showing up in real government spending. I would expect that neither the costs nor the benefits of government stimulus would happen until the money is actually spent, not just allocated.

The Bank of Japan plans to soak up a lot of the issuance that will facilitate the extension of stimulus.

This is monetizing the debt. I have no problem with the action, although I would place higher odds on effective monetary policy if they were not simply providing funds to the private sector. Japan certainly has room to print money if they desire. Yet, printing money is an inflation tax and it lowers the real value of bond holdings.

Why does Japan seem so relatively stable?

I would argue that it does not. Japan’s banks entered this recession with almost no exposure to subprime assets and very little exposure to asset-backed securities. At the start of the crisis, the bank’s were very well capitalized and indeed provided a substantial amount of capital to U.S. and European banks. Yet, at least until the rebound, Japan’s economy seems to be suffering more than any other industrial economy with the possible exception of Iceland and Ireland.

Already in the fourth quarter (after the first round of stimulus), GDP fell more than 12 percent. Most analysts expect a fall at least that bad in the first quarter.