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Japan, Germany and the challenge of excess savings

Will Japan abandon its ultra-loose monetary policies now that Kazuo Ueda has replaced Haruhiko Kuroda as governor of the Bank of Japan? The answer, it seems, is “no”. The new governor, a well-known and respected academic economist, stressed that the two pillars of Japan’s current monetary policy — negative interest rates and yield curve control — remained appropriate. Was he also right to stick to these policies? On balance, my answer is “yes”. This is not because this is without risk, as Robin Harding argued last week. But because the alternatives are risky, too.

Even if one ignores the BoJ’s asset purchases (or “quantitative easing”) and more recent policy of yield-curve control, the striking fact remains that its short-term intervention rate has been 0.5 per cent, or lower, since 1995. How many economists would have guessed that a country could run such an accommodative monetary policy for almost three decades and yet remain worried about weak demand and low inflation?

This is clearly a deep-seated structural phenomenon. So what has caused it? The answer is chronic excess savings. Japan is not the only large market economy with a strong manufacturing sector and structural excess savings. The other is Germany. But Germany has had an answer Japan does not have: the euro.

Japan’s private sector gross savings averaged an extraordinary 29 per cent of GDP between 2010 and 2019 (before the shocks of Covid and the Ukraine war). This was well above Germany’s 25 per cent and far above the 22 per cent of the US and the absurdly low 15 per cent of the UK. Japan’s private sector also invested a (quite probably) excessive 21 per cent of GDP. Yet this still left surplus savings of 8 per cent of GDP. Germany’s private savings surplus averaged 6 per cent of GDP, that of the US 5 per cent and the UK’s close to zero.

In the economy as a whole, savings must equal investment once one includes the government and foreigners. The question is how that balance is achieved and crucially, as Keynes taught us, at what levels of economic activity. With a big enough recession, profits (and so corporate savings) would presumably collapse. But it would have to be an enormous collapse. In every year from 2000 to 2020, including recessions, Japan’s corporate retained profits exceeded 20 per cent of GDP. Similarly, with a big enough recession, household savings would collapse. But if such a recession were to occur, investment would collapse, too. The outcome would be a dire depression.

No sane policymakers would try to eliminate excess savings via a slump. Instead, they would choose policies aimed at either absorbing the savings in productive investments or reducing the country’s propensity to save.

A sensible way of thinking about what Japanese policymakers have been doing since the end of the high investment phase of Japan’s postwar catch-up economy in the early 1990s is this: they are trying to sustain aggregate demand in the context of the huge surplus savings of the private sector. This is another way of saying that they are trying to escape from deflation, which would, in the absence of their efforts, probably have been far deeper than it was.

Ultra-low interest rates are, for example, intended to raise private investment and reduce private savings. But in practice, the private savings surplus, especially the corporate surplus, has remained huge. Loose monetary policy has facilitated crucial absorption (and offsetting) of surplus private savings via the excess of government investment over savings. These deficits averaged 5 per cent of GDP from 2010 to 2019. Finally, an average of 3 per cent of GDP went into net acquisition of foreign assets via Japan’s current account surpluses.

Were there other ways of managing the structural surplus savings problem from which Japan has been suffering for a decade (and, not coincidentally, China has been suffering increasingly, too)? Yes, there were three alternative ways.

One is Germany’s: its net acquisition of foreign assets averaged 7 per cent of GDP from 2010 to 2019. This allowed both private and public sectors to run saving surpluses, while balancing aggregate supply and demand at reasonably high levels. There are two reasons why this approach would have been hard for Japan to copy. One is that the trade surpluses would have run head on into US mercantilism. The other is that there would have been fierce upward pressure on the yen exchange rate, compounding the deflationary forces on Japan. Indeed, if the euro had not existed, currency crises in the exchange rate mechanism would surely have forced huge revaluations of the D-Mark, pitching the German economy into deflation and ultra-easy monetary policy, whatever the Bundesbank wanted.

The second alternative is structural policies aimed at lowering the extraordinarily high share of retained corporate earnings (or corporate savings) in the economy. This is essentially a distributional problem: wages are too low and profits too high. The simplest way to fix this is to raise the rate of tax on corporate profits, while allowing full expensing of investment. Other ways could be found, such as distributing profits to employees. But the goal would be clear: to shift excess profits into consumption.

The third alternative would be to leave the structural problems untouched, tighten monetary and fiscal policies and leave the Japanese to pick up the pieces. This is “liquidationism”. It is becoming fashionable nowadays. It is also irresponsible nonsense. So long as Japan continues to run huge excess private sector savings, policy has to find ways of either reducing or offsetting them. Japan’s economy is still trapped. It also has no easy way out.

martin.wolf@ft.com

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