The Japanese society as a whole was hit hard by the Showa depression, especially in rural areas. Rural impoverishment became severe around 1931. During the Showa depression the Japanese public became greatly frustrated with the deflationary policy of the second Wakatsuki Cabinet and, finally, the government was removed and was succeeded by the Inukai Cabinet in December 13, 1931. (Ohno)
Korekiyo Takahashi: The Japanese Keynes
Veteran Korekiyo Takahashi came back as Finance Minister for the fifth time in his career (Shizume). Takahashi is often described as the Japanese Keynes. Long before John Maynard Keynes published it famous book The General Theory of Employment, Interest and Money in 1936 Takahashi adopted Keynesian politics.
Takahashi's policy has drawn attention from economists, historians and policy makers from around the world. Among them Ben Bernanke who has spoken highly of Takahashi's accomplishments by stating that: " Finance Minister Krekiyo Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies in the early 1930's." (Bernanke) Other observers noted that: " It was inevitable that Japan should go off the gold standard (...) What followed probably could not have been anticipated: one of the most successful combinations of fiscal, monetary, and foreign exchange rate policies, in an adverse international environment, that the world has ever seen (...) " (Hamada)
Like Shinzo Abe today did Korekiyo Takahashi follow a three pillar strategy to revive the Japanese economy. Namely, currency depreciation, fiscal stimulus and monetary expansion. Thus, Takahashi is the intellectual father of the fiscal and monetary policy of Shinzo Abe, the so called Abenomics. Actually, Abe's policy is just an imitation of those Takahashi prescribed Japan after the Showa depression and therefore the policy mix would be better labeled "Takahashinomics".
This post is the last on a series of writings on Japan's other "lost decade", concentrating on Takahashi's economic policy response to the Showa depression. The first post, which is to be found here:Japan's Other "Lost Decade" - The Showa Recession and Financial Crisis , presented Japan's Showa recession of the 1920's. The second one, to be found here:Japan's Other Lost Decade - The Showa Depression , concentrated on Japan's depressionary period of 1929-1931.
Takahashi's Economic Policy
Just months after his return as minister Takahashi moved Japan off the gold standard in December 1931. The yen immediately depreciated significantly. (Shibamoto) In addition, Takahashi prescribed Japan fiscal stimulus and an easy monetary policy over the following few years. But the medicine that Mr.Takahashi was administering the Japanese economy was by no means a fast-selling item with the general public. He faced fierce opposition by the people at the beginning of its term.
An editorial in a Japanese newspaper during that time stated that: " (...) recent policy for inflation is intended to lower the value of money and to increase prices of goods by issuing more currency. The recovery obtained by such a policy is not a real recovery that would come from restoration of business activities (...) Some measures for relief of business might be needed. If it went so far as to step forward an excessive expansion of money, however, this policy would break the foundation of our currency system and ruin all of our businesses (...) We eagerly hope that the government makes every possible effort to contain the inflation within a certain appropriate limit and to prevent various harms that would be generated by inflation (....). " (Hamada)
Only when Takahashi's policy gained traction and bore fruit did the public opinion start to cautiously shift in favor of its policy mix.
" (...) we can notice that more and more countries in the world have been moving toward a policy of reflation in order to resolve depression since the beginning of this year. Incidentally, our nation is running the forefront of this stream. Although it is quite difficult to predict what this stream will bring about in the end, we have clearly realized that its net benefit in this transitional period seems to be substantial. The problem for the next year is how we can minimize the fiscal, economic, and social costs of the ongoing policies, and pave a road toward a true restoration of the balance in government finance and the growth of the private economy (...). " (Hamada)
Takahashi's policy regime has since been labeled as the “Takahashi economic policy.” As mentioned before it was a three-pronged macroeconomic policy with exchange rate, monetary, and fiscal dimensions. But what was the exact composition of his policy mix and what did it entail?
First and foremost, under Takahashi's exchange rate policy the yen was allowed to depreciate by 60 percent against the U.S. dollar and by 44 percent against the pound sterling. The depreciation of the yen took place in a very brief moment of time, from December 1931 to November 1932.
Perceiving that a further depreciation of the yen would be unfavorable to the Japanese economy, the government took steps to stabilize the exchange rate. From April 1933 onwards, Yokohama Specie Bank, the official foreign exchange bank of Japan, set the exchange rate quotation in pound sterling, effectively pegging the yen to sterling.
Meanwhile, foreign-exchange and capital controls in Japan remained surprisingly mild through 1936. (Shizume) Surprising it is because according to the notion of the macroeconomic policy trilemma, any chosen macroeconomic policy regime can succeed in achieving only two out of the following three policy objectives:
a) Independent monetary policy oriented toward domestic objectives;
b) A fixed exchange rate; and
c) Full freedom of cross-border capital movements
The currency peg theoretically implied that Japan was obliged to follow slavishly the monetary policy of the United Kingdom. But given that the United Kingdom had been conducting a relatively lax monetary policy on their own, Japan still was able to follow fiscal and monetary policy actions aimed towards domestic objectives without foreign exchange and capital controls. (Shizume)
In addition to stimulative measures through depreciation of the exchange rate, the interest rate policy by the BOJ was highly accommodative. It cut its official discount rate significantly in March, June, and August 1932. Meanwhile, the regulation on bank note issuance was amended in June to raise the limit of fiduciary note issuance from 120 million yen to 1 billion yen. (Shizume)
Finally, fiscal expenditures was increased significantly. More importantly the deficit spending by the Japanese government was backed by the BOJ. The monetization of the fiscal deficit, in which the BOJ bought up newly-issued government bonds, was tried for the first time in Japanese history.
A newspaper reported that Takahashi had mentioned the BOJ underwriting of government bonds for the first time on March 8, 1932, at a meeting with financiers. On June 3, the government submitted a bill to issue deficit-covering bonds. The bill was accompanied by a supplemental budget that was outlaying expenditures for military action in Manchuria (Northeastern part of Chinese Continent) as well as an emergency relief program in rural areas. Then, on the same day, Takahashi officially announced the BOJ underwriting of government bonds. The bill and supplemental budget passed on June 18, marking a full-fledged start of the stimulative fiscal policy of the Takahashi era. The BOJ started underwriting government bonds on November 25, 1932. (Shizume)
The Outcome of Takahashi's Experiment
Takahashi fiscal policies not only created demand through expanded fiscal expenditures but also included reflationary measures aimed at restoring gradually rising prices. After two years of almost double-digit deflation in 1930 and 1931, Japan finally escaped from the deflationary trend in 1932. In 1933 and 1934, personal spending and business fixed investment once again fuelled a growing economy. (Kuronama)
By 1934, when the Japanese economy was firmly on a path to recovery, Takahashi slowly shifted back to a tighter budget. That seemed an appropriate decision at this point of time (Ohno), because during Takahashi’s term, there was virtually no formal mechanism for keeping the ever-growing budget in check. Especially the ever increasing war funding was a thorn in Takahashi’s flesh, as he was well aware that it was his presence that was the only agent of fiscal discipline: The governance of fiscal policy depended on his own capabilities and will. (Shizume)
During the budgetary process of fiscal 1936, the Ministry of Finance, under Takahashi’s leadership, tried to reduce the fiscal deficit more radically. While it succeeded in reducing new government bond issues to some degree, the reduction was far from the level required. The negotiation increased tensions with the military. (Shizume) The army and navy continued to demand more military spending despite fiscal pressure. (Ohno) Those tensions between the Japanese military and the government paved the way to Takahashi’s assassination by a group of militarists on February 26, 1936. The conflict culminated into a complete loss of fiscal discipline as Japan moved to a wartime command economy. (Shizume)
Non- Takahashi Positive Shocks
Literature states that there were at least three important non-Takahashi positive shocks to the Japanese economy, which facilitated and contributed to Takahashi's success.
The first one was the recovery in the rest of the world. It provided Japan an export demand stimuli on top of the effect of the yen depreciation, deficit spending and monetary expansion.
Secondly, as in many other countries, a consequence of the Great Depression was that the liberal policy regime of the 1920s became discredited and state interventionism gained force under Japanese officials. The shift in the policy regime was pioneered by “new bureaucrats”. These reform-minded technocrats wanted to establish a system of control and to replace the market system, as they were highly disillusioned with corrupt party politics and the instability of market economy as witnessed during the 1920s. The transition found one expression in the legislation of the Major Industries Control Law (Juyo Sangyo Toseiho) in 1931. The law was not intended to impose direct state control over companies, but rather to encourage “cooperation” among firms in designated “important industries” by forming depression cartels. Meanwhile, the Ministry of Commerce and Industry remained in a position to influence investment decisions and output- and price-fixing agreements. (Soo Cha)
Furthermore, during the 1930s various laws, notably the Petroleum Industry Law of 1934 and the Automobile Manufacturing Law of 1936, were introduced to promote specific industries, mostly the heavy and chemical industry. The “heavy and chemical industrialization” drive not only stimulated investment activity, and thus contributed to the recovery, but also was welcomed by the military, which had been persistently demanding to get prepared for a war in order to consolidate control over China since the Manchurian invasion. (Soo Cha)
The third and final non- Takahashi positive shock concerns the Japanese labor market. In the U.S. labor unions were encouraged under the New Deal and other labor protection laws were introduced, in order to raise real wages. The Nazis in Germany, on the other hand, destroyed labor unions quickly after taking power, and the government intervened in the process of wage bargaining, exerting downward pressures upon the level of nominal wages.
Japan in the 1930s resembled Germany more than the U.S. In the new political environment created by the Manchurian invasion and the rightwing terrorist attacks, both independent unions and proletarian parties suffered a serious setback. Unionization rate declined from a peak in 1931, and the number of workers in labor disputes as a proportion of total also fell. Under such circumstances, the real wages in Japan declined significantly. Some observers see this phenomenon as the most significant contributor to Japan's remarkable economic performance between 1932 and 1936. (Soo Cha)
Which of Takahashi's Policy Tool was the Most Effective?
A controversy exists regarding the efficiency of the individual policy tools Takahashi applied.
Soo Cha (2000) notes that devaluation did help during 1932, but sees its contribution to output growth in Japan as rather modest. Also does he see Takahashi’s fiscal expansion only partially responsible for Japan’s successful recovery story. He stresses that both world recovery and the shift to a system of bureaucratic and military control played important parts not only in ending the depression, but also in sustaining the recovery.
Furthermore, downward wage shocks were significantly contributing to the rebound in the early 1930s. When the finance minister started to reduce deficit spending from 1934 onwards, both world recovery and an investment boom took over to sustain the growth. The investment boom most likely was created by industrial policy to promote heavy industries, launched by technocrats trusting the superiority of bureaucratic over market rationality. He sums it up by noting that: "(...) it is true that Takahashi’s capable policy response was critical in ending the downswing quickly, but without the intervention of world recovery and political regime shift, Japan’s hypothetical growth performance in the 1930s would have been far less impressive than actual." (Soo cha)
In contrast to Soo Cha does Shibamoto et al. (2011) regard the depreciation of the yen, changes in inflation expectations, and unexpected price changes as vitally important factors to production growth after Japan departed from the gold standard in December 1931.
His findings suggest that monetary and fiscal policies had very limited effects, if any. For Shibamoto et al. (2011) it was the change in the exchange rate that played the most important role in accounting for the Japanese economic recovery during the early 1930s.
He goes on to note that particular during the second half of 1931 speculation on Japan’s departure from the gold standard and the inflation likely to follow reversed the public’s expectation from deflation to inflation, well ahead of the actual departure at the end of the year.
Thus, it were the inflation expectations that played a substantial role in the dynamics at work. Regarding monetary policy he suggests that independent shocks in monetary policy accounted for little, not only in the economic recovery during the Takahashi term, but also in the variations in the money stock. The independent policy shifts may have been effective at that time, but the monetary policy response largely accommodated changes in economic conditions and other policy changes such as the exchange rate settings. (Shibamoto et al)
A number of observers who focus on the macroeconomic aspects of the Takahashi economic policy praise Takahashi’s as a visionary and his achievements as a successful pioneer of what would later be labelled Keynesian economics. Kindleberger points out that Takahashi conducted quintessential Keynesian policies, stating: “his writing of the period showed that he already understood the mechanism of the Keynesian multiplier, without any indication of contact with the R. F. Kahn 1931 Economic Journal article.”
The gist of this argument is that the macroeconomic stimulus policies during the Takahashi era contributed to growth in aggregate demand in Japan, and that Takahashi’s macroeconomic policy consisted of a combination of three elements: a) depreciation of the yen (exchange rate policy), b) increase in government expenditure associated with the underwriting of deficit-covering bonds by the BOJ (fiscal policy), and c) interest rate cut (monetary policy). (Shizume)
Under Korekiyo Takahashi monetization of the fiscal deficit, in which the BOJ bought up newly-issued government bonds, was tried for the first time in Japanese history. Interest rates were lowered and the money supply expanded significantly. Which of Takahashi's instruments contributed most to the Japanese recovery is up to debate. But nevertheless did the Japanese economy began to recover in 1932 and expanded relatively strongly until 1936, the last year of the non-wartime economy. Among major countries, Japan was the first to overcome the Great Depression of the 1930s. Apparently, Takahashi's tool box worked well. (Ohno)
Today, Takahashi’s policy is admired while Inoue’s policy is widely criticized as stubborn and misguided. But this view can be challenged, because the yen’s sharp depreciation might be considered as a “beggar-thy-neighbor” policy. It was a policy that could offend other countries since Japan promoted its exports at the cost of reduced competitiveness of its trading partners. (Ohno)
Links to related posts:
The Showa Recession and Financial Crisis - Japan's Other Lost Decade
The Showa Depression - Japan's Other Lost Decade
Ben Bernanke; Some Thoughts on Monetary Policy in Japan, Remarks by Ben S. Bernanke, Member, Board of Governors of the Federal Reserve System, before the 60th Anniversary Meeting, Japan Society of Monetary Economics, Tokyo, Japan, May 31; 2003.
Myung Soo Cha; Did Korekiyo Takahashi Rescue Japan from the Great Depression?; Discussion Paper Series A No.395; August 2000
Koichi Hamada; Asahi Noguchi; The Role of Preconceived Ideas in Macroeconomic Policy: Japan’s Experiences in the Two Deflationary Periods; CENTER DISCUSSION PAPER NO. 908; March 2005
Yuji Kuronuma; Showa Depression: A Prescription for "Once in a Century Crisis"; Japan Center for Economic Research; April 2009
Kenichi Ohno; The Economic Development of Japan: The Path Traveled by Japan as a Developing Country; GRIPS Development Forum; March 2006
Masahiko Shibamoto, Masato Shizume; How Did Takahashi Korekiyo Rescue Japan from the Great Depression?; Research Institute for Economics and Business Administration, Kobe University; Institute for Monetary and Economic Studies, Bank of Japan August 1, 2011
Masato Shizume; The Japanese Economy during the Interwar Period: Instability of the Financial System and the Impact of the World Depression; Institute for Monetary and Economic Studies; May 2009
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