7/29/2019 Question: While the British government is trying to reduce its deficits, the Japanese government, with debt/GDP o

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Question: While theBritish government istrying to reduce itsdeficits, the Japanesegovernment, withdebt/GDP over 200%, hasannounced a further fiscalstimulus. Consider themotives for these

different policies.

2013

ECON 404: INTERNATIONAL BANKING& RISK MANAGEMENTWALTER TAYLOR

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INTRODUCTION

The significance of fiscal policy undertaken by British and Japanesegovernments has intensified since the global financial crisis of 2008,where both economies were harmed due to the slowdown of exports

caused by the global recession. This had vast ramifications as globalinstitution had to be rescued from the brink of collapse, as seen withthe financial sector within the United Kingdom. It was necessary to aidthese banks in need as they were too big to fail, with any collapsehaving a drastic consequences for their economy and the people whohad savings tied into those institutions. This heavy burden requiredgovernment borrowing which placed the deficit of the UK at 151million towards the end of the labour government.

The Japanese government has a slightly different problem in the sensethat it has experienced deflation for nearly 20 years since 1990 anddoesnt have the problem of rescuing financial institutions. After theasset bubble burst of 1991, the Japanese have been trying to expandtheir economy through monetary and fiscal policy with efforts such asquantitative easing being undermined by the actions of other relatedeconomies. The Japanese economy has stagnated and currently has thelargest debt to GDP ratio in the world with 226% of annual GDP worthof Government debt. The diagram below (Roxburgh, 2012) also showsthe difference between the Japanese and British economies in respectto massive financial bailouts which Britain had to enforce, something wewill discuss later.

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S TIMULATING A N ECONOMY : V IEW F ROM JAPAN

The current situation in Japan is heavily influenced by the fiscal policy of the 1980s where Japan was experiencing continuous growth. The1990s saw a slowdown and burst of the asset price bubble with the

financial ministry slashing interest rates, eventually to 0% in an attemptto stop deflation and increase consumer spending. The recession led toa change in consumer preferences with many in Japan tending to savetheir money causing what Krugman (2000) called the liquidity trap. Byincreasing the money supply, more money should enter circulation andmore people should be empowered to spend. This theory fromKeynesian economics means that growth should occur but theframework was flawed as it didnt take into account the hol d of moneywithin relative institutions or the Japanese propensity to save. This iswhere the Keynesian theory can falter because Japan has continuously

tried stimulus with little success, meaning debts have risen further withthe prospect of repayment becoming more oblique. Their current debtlevels are only sufficient due to the high quantity of foreign assets whichsustains the minimal growth that stops deflation (Shilling,2012).

Another problem experienced by Japan is the appreciation of theircurrency after 2008, when other governments used quantitative easingmeasures to devalue their currencies, resulting in the Japanese yenbeing relatively overvalued and out priced in the exports market, badlyharming the export driven economy. A strong yen is terrible for japanand the only way to address the issue would be further quantitative

easing from the Japanese authorities which could lead to a race to thebottom if other struggling economies do the same. The global recessionhas limited the effectiveness of these techniques applied by japan so achange of course may be necessary, possibly trying to peg theirexchange rate to a relative currency in the hope that it provides somesort of stability (possibly the RMB).

A USTERITY M EASURES : B RITISH A PPROACH

In Britain a different fiscal policy has been implement with large cuts to

public sector spending. These cuts were necessary due to the large bailouts in 2008 resulting in the dramatic government debt increase from38.4% of GDP in October 2008 to 73.8% as of January 2013 (Rodgers&Kollewe,2013).

The austerity policy meant a reduction in spending in all public areasexcept education, health & foreign aid which were unaffected. Thesemeasure have meant a cut in borrowing from 151 billion in 2010 to

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114 billion in 2013, with spending expected to be cut further toborrowing of 45 billion by 2017 although these estimates have beencontinuously re-assessed so their credibility is somewhat lacking(Knight, 2013).

One of the key motives behind the cuts was an attempt to secure theAAA credit status given by financial rating agencies. This would allowcheaper rates of government borrowing whilst the bailing out of institutions was taking place, with cost continually rising well after the2008 crisis was over. The rating was lost in 2013 due to a combinationof low growth and the perceived lack of determination in reducing thedeficit, with some members of parliament calling for further cuts withina shorter time frame to reduce the period of stagnant growth withinBritain.

The motives for these cuts also have political motives as theconservative party are usually adverse to taxation and favour a morelimited role for the state. While not economic, the relevance of this wasapparent in the 2010 general election where the Tories gained powerthrough a coalition agreement with the Liberal-Democrats. This hashampered the effectiveness of proposed cut backs as the liberals haveopposed such moves meaning compromises have to be met.

These cuts essentially mean that the UK is trying to encourage privateenterprise as the main driver for growth, with the government onlyenabling firms to invest through different incentives such as thereduction in corporation tax which now stands at 20%, the lowest in anywestern economy. This shift towards private enterprise is similar to theeconomic policy of the 1980s when under Margret Thatcher theconservatives announced cuts to public spending and privatisation of firms, although this time the global downturn means that Britain cannotsimply devalue her currency to increase exports because her mainexport markets (EU & US) are in similar dire straits.

T HE D EFICIT D ILEMMA

The Japanese conundrum is one that may need a shift in culturalpreferences before it is solved. With their high propensity to save, theirdomestic market cannot grow while their reliance on exports has showntheir fragility in times of global economic downturn. It needs to addressthe problem of currency appreciation which happens due to externalfactors. This could be addressed with an exchange rate peg with nearbyChina in the same way that Switzerland manages its own exchange ratethrough open market conditions. The demographic problem within

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Japan is an issue beyond economic theory but essential to their decline,the strict immigration laws mean that they cannot utilise additionalhuman capital that could help facilitate growth. .

The UK needs more investment in areas such as construction that couldlead to growth because cuts have led to a slight reduction of GDPcomparative to pre- 2008, with events such as last years Olympicsproviding short term relief. However its clear that austerity measuresare still needed to maintain confidence within the economy, allowingaccess to low borrowing rates which will be vital for years to come asthey continue to service their debts. It needs to find a way to boostinvestment with ideas such as negative interest rates being raised tostop the large holds of savings but while this would encourage morelending to consumers in the UK, it would have a devastating effect ongilt yields and repercussions on pension funds.

Other initiatives such as the funds for lending scheme have beenimplemented to little effect because the banks simply wont lend toeach other, instead deleveraging their balance sheets and cutting backtheir liabilities. Any attempt to insert more capital into the market isbeing undermined by the institutions who simply store capital as savingsand dont pass it onto the consumer. Japan has the sim ilar problem thatany money injected into the economy does not enter circulation and isheld by the public, so debt to GDP raises without the intended effect of boosting the economy, which in turn means that Japan can only carryon stimulating the economy or propose austerity cuts which wouldamount to possible rioting and certain political suicide.

C ONCLUSIONS

The actions taken by both economies stem from the effects of theirnearest trading partners, with their growth dependent on the growthwithin Eurozone and US respectively. Japan has chosen to stimulate tomaintain high income level which continue to increase, even during itslost decade(s) whilst the UK is trying to relieve some of the toxic debtpicked up during the financial crisis. While the argument between theKeynesian and Hayek theory can go on, the situations are complicated

by both economies reliance on external factors, as seen with thefinancial crisis in the US effect the Britain and the depreciation of currencies with Developed economies harming Japan. National cultureof two countries has some importance in these decisions because thecurrent paths chosen by Britain and Japan are similar in retrospect tothat of previous administrations since the war.

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R EFERENCES

Knight, L. (2013), Budget 2013: What the numbers really mean, BBC News , Accessed on 21/03/2013, [http://www.bbc.co.uk/news/business-21866721 ].

Krugman, P. (2000), Thinking about the liquidity trap, Journal of Japanese and international economies, Vol.14, No.4, p221-237.

Rodgers, S. & Kollewe, J. (2013), Deficit, national debt and governmentborrowing- how it has changed since 1945? The Guardian , Accessed on20/03/2013,[http://www.guardian.co.uk/news/datablog/2010/oct/18/deficit-debt-

government-borrowing-data ].Roxburgh, C. (2012), Debt and deleveraging: uneven progress on thepath to growth, McKinsey & Company , Accessed on 19/03/2013,[http://www.mckinsey.com/insights/global_capital_markets/uneven_progress_on_the_path_to_growth ].

Shilling, A.G. (2012), Japans debt sustains a deflationary Depression,Bloomberg , Accessed on 19/03/2013,[http://www.bloomberg.com/news/2012-06-04/japan-s-debt-sustains-a-deflationary-depression.html ].

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