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The Global Economy: Expansionary Fiscal Policy & Monetary Easing

The Global Economy: Expansionary Fiscal Policy & Monetary Easing

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The Global Economy: Expansionary Fiscal Policy & Monetary Easing

Introduction

Both monetary and fiscal policies are highly influential within Japan’s economy. In definition, a monetary is normally put into practice by the central bank while fiscal policies are implemented by the national government. Typically, monetary policies act to realize macroeconomic objectives for instance, stable economic growth and price stability. Conversely, fiscal policies have a broader range and are long term in nature. Their main objectives include controlling spending and taxes. In Japan, the Ministry of Finance plays a significant function in coordinating and promoting economic growth. The ministry was crucial in backing a “growth first” strategy characterized by a high amount of state expenditure being awarded to capital accumulation, and reduced government spending generally that suppressed both deficit spending and taxes. This created more money for private investment. The recent expansionary fiscal policy and money easing strategy adopted after a financial crisis has evoked many reactions especially from domestic stakeholders over its practicability and future consequences. While their introduction aimed at increasing the amount of money in the economy and stabilizing it simultaneously, their effects have created uproars begging the need for a clarification on the rationale behind the monetary and fiscal policies adopted by Japan. A large part of the impact of Japan’s expansionary policy has had positive results on the economy and other financial aspects.

Effect on the economy

To understand further, how the expansionary and monetary easing affects the economy of a country as well as the global economy, Japan’s case is considered. In 1980s, Japan was hit by the biggest financial bubble in history. Two decades after the bubble burst in 1989, the country has hit its lows with weak growth as well as low deflation that indicated the GDP has not been growing. After the bubble, 15 years of restrictive macroeconomic policies followed. However, the result was an increasing debt to GDP ratio as well as the collapsing tax revenue and increased social spending. The monetary policies had not made any significant achievement in terms of stimulating economic growth. To stimulate economic growth, Japan is currently engaging in an extraordinary budget of 15billion Yen in 2013. Additionally, the central government states it will double the money supply, monetary easing, in order to encourage growth as well stop the falling prices. It also intends to increase the purchase of government bonds by 50 trillion Yen, about $500 billion. Nevertheless, using these easing policies poses significant effects to not only Japan but also other domestic and global economies over the short-term and the long-term economies as further explained.

As mentioned, quantitative easing involves initiating an unconventional monetary policy by the central bank in order to augment the respective economy based on the failure of the customary monetary policy. A typical monetary policy involves a process through which the central bank manages the money supply in order to endorse economic growth and constancy. According to Langdana (2009), expansionary monetary policies concentrate on amplifying the sum money supply within a particular country in a short-term basis. Usually, such policies support the Circular Flow of Income. Accordingly, since expansionary monetary policies focus on fighting unemployment within recession through the decrease of rates of interest, they motivate businesses to expand, which in turn increase the amount of goods within the market. This persuades an increase in purchasing power from consumers due to the wide variety of goods within the market. As such, an increase in purchasing power correlates to an increase in revenue to the government. As such, the income flow throughout the economy constitutes an incessant flow of manufacture, revenue and expenditure (Dolan, 2007).

Nevertheless, the sole objective of conducting the monetary policy by the Bank of Japan involves the maintenance of price stability in order to develop the national economy soundly. This is in accordance to the problem of deflation evident within the country ever since the collapse of the Bubble economy in the 1990s (Fujiki, Okina & Shiratsuka, 2001). At that time, the Bank of Japan integrated a Zero-Interest Rate policy in which the Japanese economy would focus on receiving substantial funds in order to circumvent potential intensification of deflation and economic decadence. Consequently, the policy concentrated on working on market prospects in order to endorse stability of interest rates. Therefore, in order to this, the Bank of Japan deemed it necessary for the economy to possess a stable supply of money at a significant degree in order to combat the pressures emanating from deflation. As such, there was the lowering of interest rates and the provision of a sufficient monetary base.

Irrespective of the adoption of the Zero Interest-Rate Policy in the 2000s following the effects of the Bubble economy, the Japanese economy continued facing sluggish performances based on incessant deflationary pressure. As such, Japan embarked on solving this problem through adoption of quantitative easing. In this case, quantitative easing involved the adoption of an expansionary fiscal policy and monetary easing in order to counter deflation (Iwamura, Kudo, & Watanabe, 2005). Berube and Pinto (2010) surmise that an expansionary fiscal policy incorporates the spending performed by the government in order to exceed the revenues arising from tax. Usually, expansionary fiscal policies undergo applications in times of recession. Even though an expansionary fiscal policy possesses complexity based on its adoption within the Japanese economy, it is sufficient for this operation. According to Langdana (2009), an expansionary monetary policy usually entails the country’s central bank purchasing government bonds at short-term to decrease interest rates at short-term. However, this does not apply in the case of the Japanese economy based on the realization that its interest rates are nearly at zero percent (Shirakawa & Ginko, 2002).

Since a typical monetary policy could not assist in decreasing interest rates in the Japanese economy, quantitative easing was necessary to implement. According to Wieland (2009), quantitative easing is crucial since it kindles the economy due to the considerable purchase of long-term assets, which in turn, decrease the interests in the long-term. As such, quantitative easing increases the values of the purchased financial assets, which leads to a significant decrease in the assets’ return value. With respect to the Japanese economy, using quantitative easing allowed the Bank of Japan to disseminate excess liquidity to banks. The reason for this was to induce private lending which would leave significant supply of surplus reserves and thus, a diminutive risk of a deficiency in liquidity. In order to carry out this strategy, the Bank of Japan concentrated on purchasing a greater quantity of the government bonds than the required amount in order to zero the interest rates.

Notably, another rationale for the adoption of quantitative easing, aside from leveling zero interest rates, involved decreasing the inflation target to 2 percent. Through the adoption of quantitative easing, the economy of Japan will experience an increase in commodity prices. Furthermore, the Bank of Japan will focus on buying government bonds for the long-term as well as financial assets that possess considerable risk. Such precarious financial assets comprise Investment trusts within the country’s real estate and exchange-traded finances (Bowman, 2011). Investing in these financial assets will ensure that the Japanese economy experiences a significant increase in cash reserves and lending from financial institutions. The effect of such measures affects the income flow within Japan’s economy. This is based on the increase in purchasing power and the level of entrepreneurship and expansion among businesses. Furthermore, the effects are likely to affect the economy in the short-term and in the long-term.

On a positive note, adopting monetary easing within the economy will actually assist incredibly in the increase in money supply within the economy. On a short-term, increasing the money supply will actually reduce the short-term rates of interest. Usually, most small and medium enterprises within the Japanese economy acquire funding from commercial institutions in order to facilitate short-term growth. As such, through reduction of short-term rates of interest, the Japanese economy will experience a considerable increase in the expansion and amplification of enterprises based on the accessibility of loans from commercial institutions. In the short-term, Japan’s economy will also experience an increase in revenue stemming from increased production and purchase of commodities by consumers due to the different and wide range of products within the market (Kimura, 2004). Another short-term effect involves currency devaluation. Devaluing the price of the Yen against other foreign countries such as the US Dollar will actually assist the Japanese economy considerably in the short-term.

A decrease in the value of the Yen against other currencies such as the US Dollar will actually induce a decrease in the prices of exports to the country from other foreign nations. Furthermore, pushing down the value of the Yen versus the Dollar will increase the strength of the Japanese Yen, as such, decrease the importation of products and raw materials from the United States, and even decrease export prices to other foreign countries within the Eurozone (Bebenroth, 2007; Reith, 2011). In addition, using quantitative easing in Japan’s economy will result in a considerable decrease in interest rates in the long-term. A long-term decrease in interest rates will be valuable for the economy based on the realization that such as strategy could increase spending and investment among firms and households (Kagraoka & Moussa, 2013). This in turn, produces considerable revenues within the economy’s income flow.

Nonetheless, assuming expansionary fiscal policy and monetary easing in Japan will pose negative effects for the economy as foreign economies. Foremost, performing quantitative easing will destabilize the financial markets (Joyce, 2010). This is because the policy will actually encourage a considerable amount of investors to accept disproportionate risk. In addition, quantitative easing will actually increase the rate of inflation based on the increased circulation of money throughout the economy. As such, an increase in income flow will actually influence a stagnant supply of commodities, which will lead to increased competition for each product. Subsequently, such competition will lead to a distortion in incomes and prices (Ito, 2010). Furthermore, the government will embark on the importation of new products and services from other countries by using novel-printed money. This will lead to devaluation of the currency of the importer and discourage exporters, thereby affecting international trade and the global economy as a whole.

Conclusion

In conclusion, using quantitative easing as a financial policy presents advantages to the Japanese economy. This is according to its effects in leveling the interest rates to zero and negating deflationary pressure. Furthermore, applying expansionary fiscal policy and monetary easing will assist greatly in increased income flow within the circulation of income. Nonetheless, the defects arising from adopting this policy pose a considerable disadvantage towards the economy in terms of global trade. Additionally, the long-term effects points that taxpayers at one time will have to pay for the debt, as well as the government spending, considering government gets money from the people. Currently, the short-term growth has been driven by government spending while decreasing the interest rates and taxes, meaning the government can only get more money from debts since income has not significantly increased or simply because there are hardly any returns. Currently the debt is about 200% of the GDP meaning that at one time in the long-term the citizens will have to pay for it. This will be quite a strain and a burden to the people.

References

Bebenroth, R., & Vollmer, U. (2007). Bank of Japan versus Eurosystem: A comparison of monetary policy institutions and conduct in Japan and in the Euro area. Intereconomics, 42, 1, 43-53.

Berube, W. J., & Pinto, C. N. (2010). Taxation, tax policies and income taxes. New York, NY: Nova Science Publishers.

Bowman, D. (2011). Quantitative easing and bank lending: Evidence from Japan. Washington, D.C.: Federal Reserve Board.

Dolan, E. G. (2007). Introduction to macroeconomics. Redding, CA: Best Value Textbooks.

Fujiki, H., Okina, K., & Shiratsuka, S. (January 01, 2001). Monetary Policy under Zero Interest Rate: Viewpoints of Central Bank Economists. Monetary and Economic Studies – Bank of Japan, 19, 89-130.

Fukasawa, E. (2000). Misunderstandings and illusions about quantitative easing. Tokyo: Fuji Research Institute Corp.

Ito, T. (2010). Great inflation and central bank independence in Japan. Cambridge, MA: National Bureau of Economic Research.

Iwamura, M., Kudo, T., & Watanabe, T. (2005). Monetary and fiscal policy in a liquidity trap: The Japanese experience 1999-2004. Cambridge, MA: National Bureau of Economic Research.

Joyce, M. (2010). The financial market impact of quantitative easing. London: Bank of England.

Kagraoka, Y., & Moussa, Z. (2013). Quantitative easing, credibility and the time-varying dynamics of the term structure of interest rate in Japan. Journal of International Financial Markets, Institutions and Money, 25, 1, 181-201.

Kimura, T. (2004). Quantitative monetary easing and risk in financial asset markets. Washington, D.C: Divisions of Research & Statistics and Monetary Affairs.

Langdana, F. K. (2009). Macroeconomic policy: Demystifying monetary and fiscal policy. New York, NY: Springer.

Reith, M. (2011). Unconventional monetary policy in practice: A comparison of ‘Quantitative Easing’ in Japan and the USA. International Journal of Monetary Economics and Finance, 4, 2, 111-134.

Shirakawa, M., & Nihon Ginko. (2002). One year under “quantitative easing”. Tokyo: Institute for Monetary and Economic Studies, Bank of Japan.

Wieland, V. (2009). Quantitative easing: A rationale and some evidence from Japan. Cambridge, MA: National Bureau of Economic Research.

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