Abenomics and Japanese Inflation Expectations

Paul Krugman has an "extremely wonky" new post about how to measure inflation expectations in Japan under Abenomics. The measure uses Treasury Inflation Protected Securities (TIPS), the topic of a series I am writing on this blog and the Noahpinion blog. Inflation-protected securities may be used to infer breakeven inflation expectations from the market. Japan's market in inflation-protected securities is considered too thin to provide useful information about expectations, so Krugman, building on the approach of Benjamin Mandel and Geoffrey Barnes, combines US TIPS data and real exchange rate data to measure Japanese inflation expectations:

I took the implied 10-year breakeven inflation rate from US TIPS, minus the 10-year interest rate differential, plus the real appreciation Japan would experience if the real exchange rate against the dollar 10 years from now were to return to its level in January 2010. You can adjust this as you like with whatever your estimate of the difference between the 1-2010 rate and the equilibrium rate is; it will just shift the line up or down.

The result is inflation expectations just below 0 until the start of 2012. Expectations rise to almost 3% by May 2013, then fall to around 1.5% by July 2013. Krugman writes:

I have my doubts about the apparent decline in recent months. It’s being driven not by events in Japan but by the taper scare, which drove up US rates. There is a question about why that rise in US rates didn’t produce a lot more yen depreciation, but something seems off here. 

The main point, however, is that this measure does suggest a substantial rise in expected inflation since Abenomics began, which is good news.

Another indicator of inflation expectations is the Bank of Japan's Opinion Survey on the General Public's Views and Behavior. According to this survey, there is no evidence of a decline in inflation expectations in recent months. The most recent survey, from June 2013, shows a continued rise in one-year-ahead expectations from December to March to June. The June average expectation was 5.1% and the median expectation was 3%. In 2010, the median expectation was 0% and the mean around 2%. Longer-term inflation expectations (which should correspond more closely to Krugman's measure) are also rising, though more gradually.

Source: Bank of Japan Opinion Survey

Also at a new high is the survey's measure of land price expectations. This is a newer development; the sharp rise began in late 2012:

Even if the expectations reported by surveyed households are not an accurate indicator of what will actually happen with inflation, they are still relevant. In the United States, households in the Michigan Survey of Consumers report higher inflation expectations than professional forecasts or TIPS-based measures. A new paper by Yuriy Gorodnichenko and Olivier Coibion, summarized by Jim Hamilton, suggests that the household expectations are important in explaining the "missing deflation" of the past few years.

Neither Krugman's US TIPS-based measure nor the household survey-based measure are perfect indicators of Japanese inflation expectations. But the fact that both indicate a rise in expectations since Abenomics began, combined with the dramatic increase in the index of land price expectations, convinces me at least qualitatively that expectations are rising, though I'd put huge error bars on any quantitative estimate. 

Krugman calls the rise in inflation expectations "good news." I agree, with a qualification. In an earlier post, "What Does Abenomics Feel Like?", I noted that Japanese consumers viewed rising prices extremely unfavorably. This, unsurprisingly, has not changed. There are, after all, no significant changes in perceptions of employment and working conditions.  In the mind of a typical consumer, more concerned with her own purchasing power than with liquidity trap economics, rising prices are not such a signifier of salvation. 

But there is a glimmer of hope. Consumers' perceptions of current economic conditions and of the economy's growth potential are both looking-- well, not bright, but brighter than before.

People are Different: A Partial Bibliography

"Turns Out People Are Different, Say Economists" is the title of Brendan Greeley's new article at BloombergBusinessweek. He writes that "the idea that different families respond differently to the same event—that households are heterogeneous—is a relatively new way of looking at the economy." This claim prompted an interesting Twitter discussion about the origins and acceptance of heterogeneous agent economics and the relevance of this literature to policymakers.

The discussion prompted me to create a (very incomplete) bibliography of heterogeneous agent literature. I've separated it into Recent Papers, Classics, and Remarks by Policymakers. I will add to it as I come across or remember other papers. I will also add papers that people suggest via the comment section or Twitter.

Recent Papers

Heterogeneous Consumers and Fiscal Policy Shocks, by Emily Anderson, Atsushi Inoue, and Barbara Rossi (2013)

"unexpected fiscal shocks have substantially different effects on consumers depending on their age, income levels, and education. In particular, the wealthiest individuals tend to behave according to the predictions of standard RBC models, whereas the poorest individuals tend to behave according to standard IS-LM (non-Ricardian) models, due to credit constraints."

Household Balance Sheets, Consumption, and the Economic Slump by Atif R. Mian, Kamalesh Rao and Amir Sufi (2013)

"the 2007-09 housing collapse in the United States resulted in a very unequal distribution of wealth shocks due to the geographical concentration of ex-ante leverage and house price decline. We investigate the consumption consequences of these wealth shocks and show that the consumption risk-sharing hypothesis is easily rejected."

Is deregulating firm entry good for the workers? Which workers? by Ana P Fernandes, Priscila Ferreira, and L Alan Winters (2013):

"deregulating firm entry appears to boost competition and employment (and possibly aggregate income) but its gains seem largely to be reaped by better-off, better-educated workers."

Fiscal Policy and Consumption, by Tullio Jappelli and Luigi Pistaferri (2013)
"A different type of experiment is a balanced-budget redistributive policy whereby the government finances a transfer to the poor by taxing the top 10% of the income distribution. With a homogeneous marginal propensity to consume, a pure redistributive policy has no effect on aggregate consumption. However, with a heterogeneous marginal propensity to consume, the effect is positive and highest if the programme targets the very poor."

Inflation and the Price of Real Assets, by Monika Piazzesi and Martin Schneider (2012)

"This paper develops an asset pricing model with heterogeneous agents and incomplete markets to study the 1970s. The key elements of the model are that households differ by age and wealth and that all credit is nominal, so that inflation matters for bond returns and the cost of borrowing. Our empirical strategy is based on the idea that micro data on household characteristics can be used to directly parametrize household sector asset demand."

Monetary Policy with Heterogeneous Agents, by Nils Gornemann, Keith Kuester, and Makoto Nakajima (2012)

"monetary policy shocks have strikingly different implications for the welfare of different segments of the population. While households in the top 5 percent of the wealth distribution benefit slightly from a contractionary monetary policy shock, the bottom 5 percent would lose from this measure"

Using Agent-Based Models for Analyzing Threats to Financial Stability, by Richard Bookstaber (2012)

"Agent-Based Models...can make an important contribution to our understanding of potential vulnerabilities and paths through which risks can propagate across the financial system." (HT David Ballard)

Center for Economic Studies, U.S. Census Bureau Working Papers, Various Authors and Years

A collection of papers addressing macro questions with microdata (HT Ryan Decker)

Classics

Income and Wealth Heterogeneity in the Macroeconomy, by Per Krusell and Anthony A. Smith, Jr (1998)

"Among the models we study, those that come the closest to matching real-world wealth distributions are precisely models with heterogeneous preferences and incomplete markets."

Asset Pricing with Heterogeneous Consumers, by George M. Constantinides and Darrell Duffie (1996)

"a potential source of the equity premium is the covariance of the securities' returns with the cross-sectional variance of individual consumers' consumption growth."

Remarks by Policymakers

Inflation Expectations and Inflation Forecasting, speech by Ben Bernanke (2007)

"median measures of inflation expectations often obscure substantial cross-sectional dispersion of expectations. On which measure or combination of measures should central bankers focus to assess inflation developments and the degree to which expectations are anchored?"

Credit, Crises, and Consequences

"What the crisis made abundantly clear is that private and public debts cannot be looked at only in isolation," say the authors of "Sovereigns Versus Banks: Credit, Crises, and Consequences." In this working paper, Òscar Jordà, Moritz Schularick, and Alan M. Taylor study the co-evolution of public and private sector debt in advanced countries since 1870. To do so, they use a new dataset covering 17 countries and 140 years.

Source: Jordà, Schularick, and Taylor

First, they find that total economy debt levels have risen a lot over time, but most of the increase has come from the private sector. The key public sector debt event was World War II (see the peak in Figure 1). Averaging across 17 advanced countries,  the ratio of public debt to bank assets went from 3/4 in 1928, to 1/2 in 1967, to 1/3 in 2008. Private borrowing is strongly pro-cyclical whereas public debt is usually mildly counter-cyclical.

Next, they classify recessions as either "normal" recessions or recessions associated with a financial crisis, and examine the cyclical public and private debt patterns associated with each. They find that private credit booms, not public debt booms, are the main precursors of financial instability.  While public sector debt has little influence on whether a financial crisis will occur, it does seem to matter for the speed of the recovery after a financial crisis. High levels of public debt are correlated with slower recoveries, which the authors contribute to fiscal space constraints, or less room to maneuver with fiscal policy.

They are careful to emphasize that high public debt is associated with slower growth only in the aftermath of financial crises. Private credit booms, on the other hand, are associated with slower growth after any type of recession.

Many countries and international bodies are considering or implementing macroprudential rules that incorporate private credit indicators. The authors support this idea in light of their findings. It is also worth considering the causes of the fiscal space constraints and whether, by making them less binding, the slow recoveries from financial crises can be sped up.