PM Ishiba’s Electionomics
Telling BOJ Not To Hike Interest Rates; Hollow Promises on Minimum Wage
Source: Wall Street Journal, Nikkei Note: See further explanation below
New Prime Minister Shigeru Ishiba is said to dislike the term “Ishibanomics,” but he’s certainly enamored of what could be termed “electionomics,” i.e., positions taken mostly to run up the Liberal Democratic Party’s (LDP) vote share—and thus his own tenure and clout as PM—even when it reverses his previous stances. Examples include:
1) instructing the Bank of Japan not to raise interest rates (in a rare violation of the BOJ’s independence), a reversal of past statements.
2) promising to raise the minimum wage from ¥1,054 at present to ¥1,500 by 2029, a goal that would require the politically impossible step of hiking it by 7.3% per year (as opposed to the 3% annual pace of the past decade); and
3) ordering his ministers to prepare a big supplementary budget to boost economic growth, while backing off from some of the tax hikes on the very affluent that he had proposed just a few weeks earlier in his campaign for the LDP Presidency. Moreover, he seems quite vague about tax hikes on corporations that he had mentioned. I’d not be surprised if, like Fumio Kishida before him, he sooner or later abandons (or waters down) that idea as well. This all contradicts his past stance as a fiscal hawk who wanted to bring down the budget deficit.
All of this makes market players publicly wonder whether Ishiba will stick to these economic stances once the election is over. No one really knows.
Ishiba is not known for any expertise or strong views on economic policy aside from aiding rural areas like his own electoral district. Nor does he have a “brains trust” of private experts to advise him akin to the small group that came up with Abenomics in preparation for Shinzo Abe’s campaign to come back to power. Rather, Ishiba is a genuine expert on security and foreign policy. To the extent that he has expressed views on economic topics, he’s regarded as part of the group of Liberal Democratic Party (LDP) Diet members who espouse conventional fiscal and monetary tightness. And so his flip-flops came as a surprise.
The Ishiba Stock Market Shock
Behind Ishiba’s reversals of policy was most likely the reaction of the financial markets to his victory, particularly the stock market.
On Friday, Sept. 27, the markets applauded when it appeared that the winner of the LDP contest would be Sanae Takaichi, a devotee of Abenomics. She was expected to successfully press the Bank of Japan (BOJ) to keep interest rates low. In fact, Takaichi said that raising rates now would be “stupid” because Japan still needed low rates to make the end of deflation secure. Low interest rates, in turn, would also help keep the yen weak, which would help the profits and stock prices of the multinational companies who dominate the stock market. And so, on Friday, in anticipation of her triumph, the interest rate on 10-year Japan Government Bonds (JGBs) fell 2.9% (from 0.83% to .807%) while stock prices rose 2.3%.
However, after the markets closed on Friday the run-off selection made Ishiba the surprise winner. Based on recent statements, markets had expected him to support relatively rapid normalization of interest rates As he was running for the LDP Presidency, he had said, “The Bank of Japan is on the right policy track to gradually align with a world with positive interest rates...Higher interest rates can lower costs of imports and make industry more competitive.” He had also supported a higher capital gains tax on investors with total income above ¥100 million ($675,000).
In response, when markets opened on Monday, interest rates on ten-year JGB interest rose 6.2% to 0.857% and the stock market cratered by nearly 5%. Alarmed at what a stock market revolt might mean for the national election on October 27, Ishiba quickly reversed himself on interest rates.
First, he met with the BOJ Governor on October 2 and came out of the meeting telling reporters: “I do not believe that we are in an environment that would require us to raise interest rates further.” It is extremely rare for a Prime Minister to give explicit or implicit marching orders on interest rate policy to the BOJ, which has been legally independent from the government since 1998 (more on this below). And yet, the markets believed that the BOJ would bend to the Prime Minister’s will, whether it was going to be Takaichi or Ishiba. So, when Ishiba reversed himself, the yen’s value fell by almost 5% as of October 8 and stocks recovered (see chart at the top).
Secondly, Ishiba abandoned any intention to raise the capital gains tax on the most affluent investors out of fear that they might flee the stock market. Ishiba’s predecessor, Fumio Kishida, had also promised a tax hike for these affluent investors and then backtracked. Fairness is the notion behind this proposal. The income tax rates are higher as one’s income increases and the rate on those earning ¥100 million or more is 45%. But the tax on capital gains is a flat 20% regardless of income. As a result, once exemptions and deductions are considered, the Finance Ministry calculates that the total tax burden typically rises from around 2.6% for people with an annual total income of up to ¥2.5 million ($17,000), to 4.6% for people up to ¥5 million, and 10.6% for people up to ¥10 million ($67,500). It peaks at 27% for the fraction of a percent of people who earn ¥100 million and then goes steadily down from there. It can be as little as 17% of those earning ¥5 billion ($33 million). There are so few people affected that this is not about raising lots of revenue, but of projecting fairness.
A Blow to BOJ Independence
Is it now clear that, despite the BOJ’s de jure independence, the financial markets no longer believe the BOJ is really independent from the government. If it did believe that, interest rates (and thus stock prices, and the yen) would not have gyrated so much in response to whether the new PM was going to be Takaichi versus Ishiba, or in response to Ishiba’s shifting comments. That’s a problem since the evidence shows that central banks with genuine and credible independence are better able to control inflation.
Until Japan’s banking crisis of 1998, the BOJ had been governed by the Ministry of Finance (MOF). Moreover, not only did the Prime Minister (with Diet approval) appoint the BOJ governor and the members of the Policy Board, but the PM could also fire a Governor who did not obey orders from the MOF and the Prime Minister. That all changed in 1998. Over the years, the MOF had made such a hash of the problem of bad bank debt that, when the crisis came to a head in 1998 and the economy was in recession, the opposition Democratic Party of Japan (DPJ) took control of the Diet’s Upper House in that year’s election. As a condition of rescuing the banks by injecting taxpayers’ money as new capital, reformers in the DPJ and LDP insisted that the MOF had to be stripped of some of its key powers. Supervision of banking was transferred to a newly-created entity called the Financial Services Agency (FSA). And the BOJ was given legal independence. As in other countries, the PM could still appoint the BOJ Governor and Policy Board members but he could not fire them.
This independence was tested in 2000 when the BOJ wanted to raise overnight interest rates from 0% (an anti-deflation policy adopted in 1999) to 0.25%. The MOF disagreed, and it pressured the BOJ to postpone the decision. The BOJ defied the government by an 8-to-1 vote of the Policy Board members and the BOJ went ahead with the hike.
Despite widespread criticism of the BOJ among elected politicians and the MOF, not until December of 2012 and the return of Shinzo Abe as Prime Minister was BOJ independence seriously challenged again. Abe was convinced by his private advisers that the BOJ could easily overcome deflation—and thus revive GDP growth—just by announcing a target of 2% inflation and pledging to do whatever it took to reach it. The BOJ said this would not work. Abe threatened the BOJ that, if it did not do what he wanted, he would revise the BOJ law to remove its independence, or at least weaken it. The BOJ surrendered and accepted the 2% goal. Since the term of the BOJ was about to end in April 2013 anyway, the BOJ Governor retired early, giving Abe a chance to appoint experts who championed the “reflationist” approach. (For an account of this, see passages in Tobias Harris’ book, The Iconoclast.) As the new Governor, he named Haruhiko Kuroda, a career MOF official who claimed he could reach 2% inflation in just two years (of course, that failed). Once the new BOJ leaders came into place, says Kuroda, Abe never gave the BOJ marching orders on how to achieve its goal or what interest rates to set—even when Kuroda failed to achieve his 2% goal. Nor did Abe’s two successors. Then, Ishiba broke this pattern.
The end result is that the financial markets no longer believe the BOJ has true independence and that, at least to some degree, it will let the Prime Minister and MOF influence its decisions. This adds to the uncertainty surrounding future BOJ decisions on interest rates and thus future yen values.
Next: Ishiba and Minimum Wages
