Japan, Germany and the Oversavings Challenge – 4/11/2023 – Martin Wolf

Will Japan abandon its ultra-loose monetary policies now that Kazuo Ueda has replaced Haruhiko Kuroda as head of the Bank of Japan? The answer, it seems, is “no”. The new leader, a well-known and respected academic economist, emphasized that the two pillars of Japan’s current monetary policy – ​​negative interest rates and yield curve control – remain adequate. Was he also right to maintain these policies? Overall, my answer is “yes”. Not because there aren’t risks, as Robin Harding argued last week. But because the alternatives are also risky.

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

This is clearly a deeply ingrained structural phenomenon. But what caused it? The answer is chronic oversavings. Japan is not the only large market economy with a strong manufacturing sector and excess structural savings. The other is Germany. But Germany had an answer that Japan does not: the euro.

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

In the economy as a whole, saving should equal investment, when government and foreigners are included. The question is how this balance is achieved and, fundamentally, as Keynes taught us, at what levels of economic activity. With a big enough recession, profits (and therefore corporate savings) would presumably collapse. But it would have to be a huge meltdown. In every year from 2000 to 2020, including recessions, Japanese corporate retained earnings exceeded 20% of GDP. Likewise, with a big enough recession, household savings would collapse. But if such a recession occurred, investment would also collapse. The result would be severe depression.

No sane policymaker would try to eliminate excess saving through a crisis. Instead, it would choose policies aimed at absorbing savings into productive investment or reducing the country’s propensity to save.

A sensible way to think about what Japanese policymakers have been doing since the end of the high investment phase of Japan’s postwar economic recovery in the early 1990s is this: they are trying to sustain aggregate demand in the context of the huge surplus of private sector savings. That’s another way of saying they’re trying to escape deflation, which, if not for their efforts, probably would have gone much deeper than it did.

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

Are there other ways to manage the structural savings surplus problem that Japan has been suffering for a decade (and, not coincidentally, China is also increasingly suffering)? Yes, there were three alternative paths.

One is Germany: its net acquisition of foreign assets averaged 7% of GDP from 2010 to 2019. This allowed the public and private sectors to run savings surpluses while balancing supply and demand. aggregated at reasonably high levels. There are two reasons why this approach would have been difficult for Japan to emulate. One is that trade surpluses would have collided with American mercantilism. The other is that there would have been strong upward pressure on the yen exchange rate, aggravating the deflationary forces in Japan. Indeed, had the euro not existed, currency crises in the exchange rate mechanism would certainly have forced huge revaluations of the Deutschmark, throwing the German economy into deflation and ultra-weak monetary policy, whatever the Bundesbank wanted.

The second alternative is structural policies designed to reduce the extraordinarily high share of corporate retained earnings (or corporate savings) in the economy. This is essentially a distributional problem: wages are too low and profits are too high. The simplest way to fix it is to increase the tax rate on corporate profits while allowing full accounting for investments. Other forms could be found, such as distributing profits to employees. But the objective would be clear: to transfer surplus profits to consumption.

The third alternative would be to leave the structural problems untouched, tighten monetary and fiscal policy, and let the Japanese pick up the pieces. This is “liquidationism”. It’s becoming fashionable nowadays. It is also absurdly irresponsible. As long as Japan continues to run huge excess private sector savings, policy will have to find ways to reduce or compensate for them. Japan’s economy remains cornered. It doesn’t have an easy way out.

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