LOWER UNEMPLOYMENT RATE NEEDED TO HIT INFLATION GOAL: JAPAN MEMBER BOARD-2018 DEEP ECONOMIC STUDY
KANAZAWA, ISHIKAWA PREF. – Bank of Japan board member Yutaka Harada said Wednesday that unemployment needs to fall further if the country’s stubbornly stagnant inflation rate is to pick up, while also advocating for continued monetary easing.
His comments, made in a speech to business leaders in Kanazawa, Ishikawa Prefecture, came after government data last week showed the nationwide jobless rate fell to 2.2 percent in May, its lowest level in a quarter of a century.
“One often hears the question of why prices are not rising even though the unemployment rate has fallen to around 2.5 percent, well below 3.5 percent, which until recently was widely regarded as the structural unemployment rate. My answer to this question is simple: the decline in the unemployment rate is insufficient,” he said.
“I do think that the current unemployment rate needs to fall further in order to achieve the price stability target of 2 percent,” Harada said, referring to the inflation target the BOJ has pursued since 2013 under Gov.
Haruhiko Kuroda. Core consumer prices, excluding volatile fresh food prices, rose 0.7 percent in May from a year earlier.
Harada, a former bureaucrat and private-sector economist who joined the central bank’s board in 2015, pushed back against comparisons that some economists have made between the BOJ’s prolonged monetary stimulus and a World War II battle in northeast India in which Japan suffered heavy losses after failing to mount a timely retreat.
“In contrast with such disastrous consequences, QQE (quantitative and qualitative easing) is clearly having a positive impact, with most economic indicators improving. Therefore, I think this analogy between QQE and the Japanese army’s Battle of Imphal is simply inaccurate.”
Harada warned that if the BOJ were to prematurely raise interest rates, it would spark a fall in bond and stock prices and an appreciation of the yen, hurting corporate profits. In that scenario, credit costs would rise, and commercial banks would suffer “substantial damage,” he said.
Unemployment
This article talks about the need for a fall in Unemployment level of Japan to achieve a target inflation1 rate(2%) set by the Central Bank of japan, initially there is a decrease in the unemployment rate from 3.5% to 2.5%.
Though there is a fall in unemployment level, it isn’t sufficient to reach the targeted rate of Inflation2 of two percent.
They are currently facing Disinflation.3 Initially Japanese population kept decreasing rapidly, simultaneously the energy prices also decreased, The price level fell from P* to P, which signifies the fall in inflation rate, this fall in price levels lead to a decline in the economy, which has now caused economic stagnation4 in Japan.
Economic Stagnation, apart from leading to a slow economic growth it also brings high Unemployment.
“Jobless rate fell to 2.2 percent in May unemployment rate has fallen to around 2.5 percent, well below 3.5 percent”.5
This situation represents a negative causal relationship between unemployment and inflation, and is modeled by the ‘Phillips curve’ 6 which helps the policy makers to anticipate trends of unemployment with respect to inflation rate or vice a versa. The short run Phillips curve(SRPC)7 presupposes a fixed SRAS curve and therefore all the movements along the SRPC are caused by changes in aggregate Demand.
1 Inflation Targeting-Inflation targeting is a central banking policy that revolves around meeting preset, publicly displayed targets for the annual rate of inflation
2 It is the sustained increase in general price levels of the goods and services?
3 consistent Fall in rate of inflation
4 Economic stagnation is a prolonged period of slow economic growth, usually accompanied by high unemployment.
5 Excerpt from the article above
6 it shows the inverse relationship between inflation and unemployment which implies that higher the inflation, lower is the rate of unemployment and vice-a-versa.
7 Representation of Phillips curve in the short run showing no trade off.
As the government initially implements contractionary demand side policies, “Harada warned that if the BOJ were to prematurely raise interest rates, it would spark a fall in bond and stock prices and an appreciation of the yen” 8
It will cause another shift from AD-2 to AD-3, Unemployment will increase while the price levels also increase, it causes a movement along the SRPC from point ‘a’ to ‘c’. Using these policies could cause huge losses in the economy.
“In that scenario, credit costs would rise, and commercial banks would suffer substantial damage,”
However if they use Expansionary Demand Side policies9 in order to achieve their target inflation and the desired unemployment rate it will lead to a shift in the aggregate demand from AD-1 to AD-2 because of which the output decreases and the price level still increase, unemployment will fall which further causes a shift from point ‘a’ to ‘b’. Demand-side policies aim to influence the aggregate demand in the economy.
Aggregate Demand is made up of Consumer Spending+Government+Spending+Investment+Net Exports (exports-imports). Generally, they are of two types: Fiscal and Monetary, either of them tend to stimulate spending of a recessionary economy. Fiscal Policies include Government spending and Taxations, it includes a decrease in personal taxes or a decrease in business taxes and increase in government spending (subsidies).
While Monetary policies include Interest rates and money supply from the central bank and since Japan is currently facing insufficient D, the government will increase the money supply and decrease interest rates so that consumer spending and investment spending increases and hence AD also increases and therefore with a combination of these policies the recessionary gap10 is covered.
However disadvantages of such policies include crowding out effect11( in fiscal policies)- when Government implements expansionary monetary policy, it regularly needs to borrow money, because of which interest rates will rise.
This thus prompts to bring down speculation and consumption spending because of the higher cost of borrowing, which counterbalances the impact of such policies and hence the currency will depreciate and the price of buying bonds will decrease
“Currency might depreciate leading to a fall in bond and stock prices of Japan.”12
Monetary policies involve built-in time lags. However, these policies can help to pull out Japan from deep recession, they can be used in specific areas like building schools, hospitals etc. They directly affect the potential output and hence the economic growth. Monetary policies can be implemented easily and do not have any political barriers because central banks run independent from the government leading to reduced bureaucracy and effective work.
8 Excerpt from the article above
9 Expansionary policies are intended to stimulate spending in a recessionary economy; contractionary policies designed to reduce expenditures in an inflationary economy.
10 This is a situation wherein the real GDP is lower than the potential GDP at the full employment level. The economy operates below the full employment level in a recessionary gap.
11 The crowding out effect is an economic theory arguing that rising public sector spending drives down or even eliminates private sector spending.
12 Excerpt from the Article above
BIBLIOGRAPHY
- Kirchhoff, Sue, and Usa Today. “Fed: Slower Growth, Higher Unemployment, Higher Inflation.” ABC News, ABC News Network, abcnews.go.com/Business/story?id=4321006&page=1.
- “Lower Unemployment Rate Needed to Hit Inflation Goal: Bank of Japan Board Member.” The Japan Times, 4 July 2018, www.japantimes.co.jp/news/2018/07/04/business/lower-unemployment-rate-needed-hit- inflation-goal-bank-japan-board-member/#.W6dQ0ugza01.
- Picardo, Elvis. “How Inflation and Unemployment Are Related.” Enron: What Caused the Ethical Collapse, This Is Calabash, 16 July 2018, webcache.googleusercontent.com/search?q=cache:APmL6SzbXyoJ:https://www.investopedia. com/articles/markets/081515/how-inflation-and-unemployment-are-related.asp &cd=1&hl=en&ct=clnk&gl=in.
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- “The Phillips Curve.” Transition Economies, www.economicsonline.co.uk/Global_economics/Phillips_curve.html.
- Tragakes, Ellie. “Economics for the IB Diploma by Ellie Tragakes.” Cambridge Core, Cambridge University Press, www.cambridge.org/core/books/economics-for-the-ib- diploma/1918CF16A8FC979AAB19951A487DCB1C.
