Arguing for Monetary Expansion

Yutaka Harada
Professor, NUCB Business School

Many Japanese economists are calling for an end to large-scale monetary easing. This article makes a counterargument for why winding down monetary easing would not only lead Japan to a return to deflation, but would also likely complicate future monetary policy.

Japan’s monetary base (MB) to nominal GDP ratio shows nominal GDP declined despite an increasing MB between 1997 and 2012 (Ono, Y., Seijuku Shakai no Keizaigaku (Economics of Mature Societies), 2012). From 2013 onwards, on the other hand, an increasing MB boosted nominal GDP, however, this growth was relatively modest. The same ratio for the UK shows a correlation between nominal GDP and MB growth, indicating that a 100 million pound increase in MB would correspond to a 60 million pound increase in the GDP. In contrast, Japan’s GDP would only increase by a mere 10 million yen.

The low coefficient between MB and nominal GDP in Japan can be explained by a  history of deflation. As the money supply increases and prices rise, individuals tend to invest in alternative assets such as stocks, land, and foreign bonds to compensate for dwindling cash and savings. Deflation, on the contrary, would encourage holding onto cash and savings. One could argue that if Japan had kept its inflation rate at around 2% as did other countries, the nominal GDP would have grown alongside MB.

In conclusion, it can be said that Japan’s MB to nominal GDP ratio does not deny the relationship between MB and nominal GDP, but rather indicates that Japan's failed monetary policy led to deflation. Therefore, prematurely ending monetary easing policy is apt to cause Japan to regress to deflation thereby complicating future economic stimulus measures.