Warnings about the economy from people you should listen to

Summary: The US economy has taxied down the runway since the end of the recession in 2009, with a failed attempt to take off each year. Now we try again. The throttles are firewalled, the crew and passengers excited at the prospect of takeoff . But some begin to worry as the end of the tarmac appears ahead. Here on the FM website you’ve read some of these concerns. Here are two reports looking at our situation from different perspectives, both confident but cautious. 

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(1)  Weekly report by Michael Hartnett, Chief Strategist, Bank of America Merrill Lynch, 12 September 2013 — Red emphasis added. As clear an analysis as I have even seen.

An unprecedented financial and economic crisis, crystallized by the September 15th 2008 bankruptcy of Lehman Brothers, was followed by an unprecedented monetary policy response, which in turn has been followed by unprecedented bull markets in bonds, stocks, and now real estate. Wall Street has soared, but Main Street has soured. The exceptional “sweet spot” engendered by generous central banks and selfish corporations has been great for owners of capital, but bad for labor. …

BoA: Wall Street vs Main Street

Significant monetary stimulus, the end of fiscal austerity, a booming housing market, a cheap dollar, record corporate cash balances — if the US economy does not significantly accelerate in the coming quarters, it never will. We assume it will…”

On the other hand — The monetary stimulus of QE3 might have little effect. Rising interest rates might slow or cripple the home construction boom. Corporate cash only stimulates if companies accelerate their rate of investment in the real economy (which does not yet appear to be happening). The unstated, even unspeakable, alternative is that the US has followed Japan in a long intractable cycle of slow growth. The next few months will show the true picture.

(2)  For a larger scale perspective see this excerpt from the long, brilliant, and disturbing “A Nominal Problem” by Jim Reid, Nick Burns, and Seb Barke; strategists at Deutsche Bank;, 12 September 2013:

The Debt Supercycle (unmentioned and unmentionable)

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Debt Supercycle

This report argues that nominal GDP is important as we live in a nominal world. We receive wages, pay our debts and manage our savings in nominal terms. In the current environment, we continue to believe that nominal GDP is more crucial than normal as we have record and climbing levels of global debt which is virtually all nominal. … In this piece we construct a comprehensive nominal global GDP series (split by regions) back to the late 1920s and find that the 5-year moving average global nominal growth rate is now at its lowest level since the 1930s. This has been driven by the developed world. But even in {the emerging nations} growth in many countries/regions is flirting with the lower end of the most recent decade range. …

Why has growth been so weak in this recovery?

This question has vexed the greatest minds in economics and the financial industry but one would have to say that too much debt has been a hindrance to many whereas trying to reduce it too quickly (austerity) has been an issue for others. The problem may actually be that growth was too high in the leverage bubble of the decade that preceded the financial crisis. As such we are flat-lining until we ‘catch-down’ with the appropriate new trend rate of growth. Perhaps this trend rate of growth has been declining due to demographics and this is now slowly being exposed post crisis. This is more true of the developed world but even in {the emerging nations} many countries are either past or are fast approaching their demographic peak

… We think nominal GDP is crucial in this cycle as the debt burden remains incredibly high relative to history. The sooner we can start to meaningfully erode it, the sooner we can reduce its inherent systemic risks and potentially free up animal spirits. …

Conclusions

… Propping up bubble-era debt with ultra low interest rates and QE has arguably locked in an inefficient allocation of resources throughout the developed world. {The emerging nations} have also been increasingly guilty of such activity post 2008. In an ideal world we would have liked to see more cleansing of debt over the last 5 years which would have helped eventually free up animal spirits, encouraged a more efficient resource allocation and allowed for more new entrepreneurial activity to prosper.

However this would have likely had a dramatically negative short-term impact on the economy and possibly on social cohesion. Politicians needing to be elected would also have been unlikely to sign off on such policy. As such we have to be realistic enough to assume that this path is now unlikely to materialize.

The authorities therefore have two options if growth continues to be so moribund. They can either continue with the just-in-time management of the problem that has existed since 2008 or they can start to be more radical and consider options that look a lot more like helicopter money. Given the worsening demographic outlook and the still systemically high debt levels such a bold approach might eventually be needed.

We’ve previously been of the opinion that the end game to the 2008- financial crisis is notably higher inflation at some point in the second half of this decade. While we continue to expect such an outcome, it has always been predicated on liberal money printing by central banks over the coming years. If Fed tapering marks the beginning of the end to this policy globally then it’s unlikely that inflation will be a big issue in the years ahead. However we think that the reduction of global central bank liquidity in a high debt, poor demographic, lower real growth world will eventually expose the globe’s economic problems again which will inevitably lead to more monetary activism. So we don’t see the expected imminent US tapering as the end of unorthodox monetary policy.

I’ll take the other side of Jim Reid’s bet on inflation. See the explanation in the posts about inflation listed below.

For other excerpts from the DB report see here.

About the debt supercycle

In the 1960’s Hamilton Bolton and Tony Boeckh of Bank Credit Analyst coined the term “debt supercycle”. See their explanation here.

Debt Supercycle

Posts about the supercycle:

For More Information

Looking at the end:

About Monetary Policy:

About inflation:

About the recovery:

  1. The greatest monetary experiment, ever, 20 June 2013
  2. Is there a recession looming in our future? Let’s review the evidence., 2 August 2013
  3. How strong is the US economy? Let’s look at drivers of growth!, 5 August 2013
  4. Status report on the US economy: where we are, where we’re going, 27 August 2013
  5. Look at the economy to see why today’s jobs report is so important!, 6 September 2013
  6. Let’s reflect on the course of the course of the US economy. Not a pretty picture., 8 September 2013

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Winds of Change

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34 thoughts on “Warnings about the economy from people you should listen to

  1. Capitalism, if not effectively counter-balanced by other forces, concentrates wealth over time. I think there is no serious debate about that. Can the concentration go so far as to be dysfunctional?

    I suggest that it can, and it has. There is no longer enough money seeking to buy goods and services to support the returns on investment wealth-holders demand. The consequence is the rise of finance for finance’s sake. As capital markets are swamped with speculation rather than investment, they cannot do their job of allocating resources efficiently; they become casinos and bubble machines, further burdening the real economy in their wake. The tail is wagging the dog, and has been for at least a quarter century.

    Wildly rising debt has hidden the imbalance for most of that time—from the wealthy, that is. The rest of us are perhaps confused, but hardly fooled. Technology—our ability, as a species and a society, to accomplish more with less effort—has clearly advanced over the past four decades. Why should it then be “hard times” for so many? It’s difficult to see, because the answer is not a who—good guys and bad guys—but a how—the ground rules we’ve taken for granted as necessary and sufficient for a prosperous nation vs. what might actually work.

    The only alternative I can see to perpetually increasing debt is redistribution… but that seems to scare Americans more than debt does.

    (As for inflation… people talk about inflation as if it really were a single number; but different things do not inflate equally—e.g., the cost of higher education has risen even faster than that of health care. We very well might not see general inflation. And what are bubbles, really, but inflation in assets? We’ve had a great deal of that sort of inflation, but the bubbles have burst rather than spreading to the broader economy and inflating wages and most prices.)

    1. “Capitalism, if not effectively counter-balanced by other forces, concentrates wealth over time.” I am not sure there is no debate about this. I certainly hear daily that it is just the opposite.

      My guess would be that any system would be fraught with boom and bust and that the concentration of wealth or at least the control(if not ownership) of wealth is inevitable. The question is how can that be undone.

    2. Doug,

      That’s a powerful point! Boom-bust cycles are inherent in free-market systems.

      Gold bugs often say that such cycles result from fiat currencies, fractional reserve banking, or central banks. All obviously false, as there were large — very large — boom-bust cycles once per-capita growth started in the western world in the mid-18th century. Before any of those financial innovations we rebuilt on a large scale.

      These cycles were so large as to be in some ways the major feature of the 19th century US and UK economies. Esp canals and railroads, the high-tech capital intensive growth-generating industries of that time.

  2. Do you have the forecast history for Mr. Hartnett? Taleb has taught me never to trust forecasts, w/o seeing their whole record.

    1. Ben,

      That’s an important question!

      Accurate economic forecasting is beyond today’s state of the art. So these are experts assessments of the situation, which is all that we have.

    2. Daniel Kahneman did research only this topic. A predicition, even if the test subject knows is false, causes an increase in confidence. Economists dazzle us with math, so they don’t have to admit the truth, no one knows what will happen over most timeframes. Currently, I think it’s better to admit you don’t know, than the illusion of confidence these kinds of forcasts try to justify.

    3. Ben,

      I agree, and that’s valuable research to keep in mind!

      Most economists are aware and admit their limited ability to make reliable forecasts. Breton quite correctly notes that these reports leave the authors’ an “out”. That is, they do not present their forecasts as certainties, and discuss alternatives. Hartnett says “If the economy…” and “We assume it will…”

      The question is not “are these forecasts 100% reliable?”, but are they useful (ie, better than nothing? I believe the answer is yes for most purposes.

      Also useful is their discussion of alternative scenarios. Knowing about other paths is as useful IMO as knowing the central tendency.

    4. I remain skeptical that they are better than nothing. They appear to work, until suddenly they don’t work, usually in a very bad way. To clarify, my main objection is that too many people use these kinds of entrail readings to justisfy what they were already going to do. To paraphrase Taleb, forecasts give you false confidence that crossing street blindfolded is safer than it really is. You have to cross the street, at least admit that you don’t know, which I know is very hard for most people, including myself, to do. Forecasts give people the illusion that you aren’t wearing a blindfold. Economic research is useful for determining points that we should not cross, like debt to GDP ratios.

    5. All valid points. However, we have to plan, and make decisions. . That requires estimates of future activity. They can either explicit by experts, on implicit (in people’s thinking) by amateurs.

      Everybody decides how best to handle these things.

    6. Forecast is easy. If nothing changes POLITICALY, economic future is easy to know.
      What will change (and change will happen 100% sure) in politics is the question, what will Congress do is the question. FED is pushing on a string, monetary policy is completely inefective. We have only fiscal policy that could change the forecast and it is, at the present slowly weakening its benefitis until it starts to make economy worse off unless something changes with politics and Congress starts to help economy.

    7. Jordan,

      If you speaking of economic forecasts, this is totally wrong:

      “Forecast is easy. If nothing changes POLITICALY, economic future is easy to know.”

      There are many factors which produce economics cycles – some very short term (eg, weather, inventories), some over medium-terms (eg, currency, interest rates, global economic changes), some over longer periods (eg, demographics). The net result is not possible to reliably predict with current tools, for several reasons:

      * data limitations (eg, quality, timeliness),
      * immature economic theory,
      * changing economic dynamics (eg, technology, monetary velocity, money multiplier).

    8. It all depends on what are your qualifiers? Is it GDP numbers? Is it unemployment? Is it prosperity? Is it inequality reduction?
      To me, i care the most about unemployment and then it would be the quality of life of the bottom 20%.
      Do you care about next quarter forecasts? Yes, they are totaly unpredictable. I do not care so much about it, i care about next year forecast and they are easy.
      There will be no changes untill wages do not start to grow and that would be easy to change with rising minimum wage to $15, so it is POLITICS that is not changing so economy will not change.

  3. Hartnett offers: “… if the US economy does not significantly accelerate in the coming quarters, it never will. We assume it will…”
    ………………
    Really? And really? Why And Why? He offers very little

    And he offers: “…a booming housing market,”. Booming? Some areas in some Cities show some uptick in Listings, some increase in prices and some yr over yr increase in Sales (ignore the rest of the elements in a very complex situation?) and this gent calls it a booming housing market?
    Compared to what historically?

    I mean read closely what he says. He has covered himself for any eventuality Note who writes his checks; this is commonly called talking your book. Invest with (no) confidence. We have never ever been here before in terms of the Global monetary situation. And this Arm Waving stuff never, ever seems to end.

    This is really a nice juxtaposition with te DB guys opining a bit later. But heavens this is not so easy as Hartnett wants to believe.

    Breton

    1. I think that’s a bit harsh. This is two paragraphs from a five page report. So not fair to say he “offers very little”.

      Housing is booming in the usual sense in which people describe markets: by change in price. Average is up ~10% YoY; hot markets are up 20%. That’s a boom, since home prices historically have risen at roughly the rate of inflation, now aprox 2%.

      And he has provided for the eventuality that he’s wrong. Accurate economic forecasting is beyond today’s state of the art, but for planning we (families, businesses, governments) need to plan. So experts give us their best guess.

  4. Why might home construction slow (building new homes is the major influence of housing on economic growth, by far)?

    Home prices are up 10% YoY; up 20% in hot markets where much of the construction happens. Conforming rates on 30 year mortgages are up from 3.75% to 4.*% YoY. What happens to the monthly payment to buy a home?

    At 10% rise, the monthly payment increases 25%

    At 20%, the monthly payment increases 36%.

    And their ability to pay for these higher nuts? Average hourly wages are up 2.1% YoY in August (from the jobs report). As for the acceleration during 2013: during the past 6 months they are up 1.9% (annualized).

    — That extra money is not all available to fund a higher home payment. The CPI was up 2.0% YoY NSA in July. July MoM was 2.4% SAAR. Hourly wage growth this year is slightly negative.

    R E C O V E R Y !

    1. RECOVERY! should be RECOVERY? (for how long?)

      Soon (…er or later) we will find that in some major Markets that this recovery is already hitting a stall and stagnation.

      Sorry.
      Debt Service at even historical low rates and stalled and pent-up Household Formation can be completely nullified by Price Increases without commensurate wage growth or disposable income advances.
      The details I could add are not worth the time or effort.

      Breton

    2. http://blogs.wsj.com/developments/2013/08/15/report-half-of-all-homes-are-being-purchased-with-cash/

      Half of all homes are being purchases all cash — no mortgage involved. There are people and companies going into the housing market, buying properties and looking to make a quick turn around. The problem with home construction is that it takes time. If you invest in constructing a home that ties down your money that increases your chance of holding the bag if/when the bubble pops again.

  5. Fiat money was THE solution to the boom and bust inherent to economies with fixed exchange rates (which is an equivalent to Gold Standard in its effects) or GD and fractional reserve banking. It is not inherent to free-market systems per se. USA did not have busts in 30 years and Yugoslavia did not have it in 40 years. is that long enough to prove that busts do not have to happen if you know how to use gifts of fiat money?
    Checkoslovakia and Hungary also 40 years without busts.

    Boom and bust cycles are not inherent to free-market systems per se as much as you could find one today in any corner of the world.

    In US, it was 90% marginal tax and active role of government that kept USA out of boom and busts. This was keeping inflation slowly rising which was making the burden of debt manageble. Once FED achieved low inflation, debt became the problem. Yes, it is a redistribution on a large scale that produced the most prosperity in the world.

    Very nice catch on 19th century cycles, btw. That is so obvious that any goldbug talk becomes just crazy idiotic lunacy once you know the past history.

  6. The simplest and the most effective solution to the economy’s problem is what Steve Keen calls Present day Debt Jubilee. Issue $100, 000 to each adult US citizen with the condition to pay off debt first. Those without debt can spend it as they want.

    WIthin a year there would be economy booming and 2% unemployment. There would be one time off inflation of around 15% annuall and thats it. Inequality would be reduced also. Boom could go on for another 10 years and then bust again unless inequality is reduced to normal levels with wage growth and moderate inflation.
    We could get 10 years to fix underling problem that is creating repeat of busts

    1. Even as a thought experiment, I can’t imagine this working out well. How would the real economy adjust to the sudden, massive increase in demand for consumer goods and services (coupled with a predictable, significant decrease in the number of people willing to do unrewarding jobs for shitty pay)? First there would be shortages, then price increases that would make 15% inflation look like a dream world… then production would adjust to the new balance, and then the one-shot money would run out… Ugh.

      And all that turmoil addresses the underlying problem only by saying we could get ten years to fix it.

      Deciding where we want to go is one crucial problem; working out how to get there from here is another. The order is important. This idea ignores the first and, for that reason alone, makes no sense as a solution to either.

  7. Jordan refers to Steve Keen, a great Oz economist but one who has, I suspect, not been able as for many US economists, to distinguish the practical, messy, confusing, current ‘main street’ (ie vs ‘wall street’) business / commercial realities……..

    I have invested in the US of A (Texas) as it seems to me it represents a real opportunity to back medium/long term judgements as to returns (this means I am completing ignore the media commentariart in Oz as it refers to the USA).

    The nonsense that is happening around the western world (over regulation at multiple levels, excessive ‘green’ regulations and …..ok this would require a separate essay) is significant threat to material security and the sustainability of our societies….

    The US has an extraordinary ability to cope, regenerate, grow and innovate……do it! Get past the mistakes [particularly some in the foreign policy space] and move on…..do what the US has always done so well

    LEAD….. and show the rest of the world what is possible, not in some bs, posturing misguided foreign policy space but in what the USA has always done……..innovate, local, committed activities that promote communities, recognise that times have changed and give local youth employment opportunities…………it’s all there, just do it

    1. “The US has an extraordinary ability to cope, regenerate, grow and innovate…..”

      Memes are fascinating things. This “USA is great” popped up this year. Gary Shilling, various Wall Street research houses, some newspaper editorials — and it gains a popular appeal.

      Nothing unique in time, of course, but varies over time. Now it’s fashionable again. It is not clear to me why. Perhaps the US government’s aggressive use of monetary and fiscal stimulus gives the impression (falsely) of a superior economy.

      My guess is that the QE-induced asset price rises are confused with actual measures of national performance. We rely on Wall Street to tells us about securities markets, for realtors and builders to tell us about real estate markets — and adopt the perspective of the rich on the health of America (asset prices, our wealth) is the measure of America — appropriate for them (since they hold almost all of it, mad for the rest of us).

    2. In an important way—one that it would help Americans to understand—“the US has extraordinary ability to cope…” is true.

      In other times (and in some places today) prosperity was highly contingent on such things as whether the crops did well, or how many of the able-bodied men were busy dying while defending the area from invaders. “Hard times” due to factors mostly or entirely outside the control of the body politic were a real possibility.

      The United States today does not find itself in that position. Nearly all of our serious problems and sufferings—our “hard times”—are the products of the systems of politics and economics to which we adhere. They are not determined by implacable, external forces, but by our own choices.

      People accept “hard times” as unavoidable too easily. This has not happened to us… we have done it to ourselves.

    3. I should perhaps hasten to add that I’m not asserting that we know how we are causing all these problems, or how to fix them. We can’t “just do it.” (We could just do something, but that is often a grave mistake.) Nonetheless, rejecting fatalism is the first step.

      Yes, we can.
      No, we don’t know how… yet.

  8. To appreciate the genius of Steve Keen’s proposed debt jubilee solution you must first reject the notion of “Loanable Funds”. This is the proposition that all loans by banks are backed by the savings on deposit by others so that banks simply intermediate this transfer of loanable funds from savers to borrowers. Why have a Fed multiplier if this were the case? The truth is at least 90% of all money loaned by banks is created as new money, and often much more than 90%. Now back to Keen.

    If Treasury distributed cash to all citizens with the proviso that debt repayment must be the first use of same, the effect on prices would be small. The repayment of debt destroys credit money just as lending creates it. The printing of money by Treasury creates money. The net effect is neither inflationary nor deflationary. Only the net printed money not used to destroy credit money would be stimulative and possibly inflationary.

    Who hates this idea?
    -Banks record loans on their books as assets. Under Keen’s plan many will become insolvent.
    -The wealthy have little debt and instinctively hate the idea of giving money to poor people even though it is a good idea to do so.
    -Politicians who like handing public money only to their crony friends.
    None of these opponents will allow Keen’s ideas to be tested. And so it goes.

    1. “If Treasury distributed cash to all citizens with the proviso that debt repayment must be the first use of same, the effect on prices would be small.”

      I can’t see it. What am I missing?

      My quick estimate is that discharging $100,000 of debt would increase monthly disposable income by anywhere from $500 to $1500, depending on the terms of the debt. If these estimates are correct:

      In United States, the average household net-adjusted disposable income is 38 001 USD a year
      […]
      In the United States, the average household net financial wealth is estimated at 115 918 USD
      […]
      In the United States, the average net adjusted disposable income of the top 20% of the population is an estimated 82 666 USD a year, whereas the bottom 20% live on an estimated 10 434 USD a year.
      OECD Better Life Index: Income: United States

      that would increase disposable income by 15-47%, for those households where the distribution went to paying off debt. Even at the low end, that seems like it wouldn’t be a trivial change. If it’s closer to the larger number, surely all hell would break loose.

      Then you have that you’re nearly doubling the average household financial wealth; and for the bottom 20% (most of whom don’t have much debt, because no one will have loaned them money in the first place), distributing nine and a half years’ income all at once.

      Seems to me you’d be throwing the dice, and damn near anything could happen.

    2. Crackpot government-run get rich quick schemes — fast! easy! safe! — have long been a feature of western society. A few have been tried — with the French leading innovators, with the Missippi Company (1671) and the Assignats (1789). None have worked well.

      The dreamers who create them — such as John Law — are hailed as geniuses. Those pointing to the past failures are ignored. Such is the way of mobs.

  9. What you describe is an increase in money velocity or turn over rate. Instead of dead ending income directly to debt service income would divert to goods and services as aggregate demand. As you say, definitely inflationary but in a virtuous way of increasing economic activity. The Fed has ample tools to remove base money should this get out of hand for example Treasury can retire sovereign debt thus absorbing liquidity. The opposite of what is happening now.

  10. I’ve read this blog for several years now dating back to when the crisis began, and never commented. I feel a need to now as I have gone full throttle trying to understand and learn reading things from both sides and trying to make intelligent judgements. We have QE, but really, who does this benefit? You can print money all day and all night, but if it never escapes the Wall St casinos into the real economy…what good does it do.

    People in the comments and the articles cited talk about housing coming back, but who is it thats buying? If it was homeowners who were living there, I’d be optimistic, but the simple facts are that its investors who are buying on pure speculation, thus driving up prices, and banks all to happy to foreclose when there is a group of investors ready to buy them.

    The other point I would like to make is about whats driving policy.

    When you have a group of delusional billionaires throwing billions to drive their policies that benefit them and their friends, there will be no recovery. I think on some strange level they think their views are correct. Unfortunately, they have no experience with anyone other than their own kind. The saddest part, however, is the utter stupidity of the average American who has been brainwashed to believe it will benefit them. When hit with facts, they will twist reality. Complexity is the enemy of transparency, and those with power will make it more complex. I just watched (painfully) a video with Jim Rogers predicting the destruction of the dollar while in the next breath saying he is heavily invested in it?!? Why are people like this are given venues to spout such nonsense? Why are those who have been wrong at every turn of this crisis given the time of day? …and more people suffer because of it.

    1. Actions like QE can affect the real economy as a result of increasing the amount of high powered money in circulation.

      But even if that doesn’t work as one might hope (perhaps due to things like interest on reserves and capital requirements that have encouraged banks just to increase amounts of their excess reserves held at the Fed as opposed to making additional loans), it can still affect things in the real world by impacting investor expectations.

      So if, for example, investors believe that Fed QE actions imply a credible commitment to a higher level of nominal GDP growth, then market prices will reflect this, much of it instantly, which in turn affects lots of things.

      For a good example of this look at the better than expected domestic demand in Japan that has arrived following investors believing the BoJ has manifested a new commitment to generating some positive inflation relative to what it’s done for the past 20 years.

      For another example, look at the SNB and their announcement to not tolerate EUR/CHF below 1.20 – looks to me that market prices very quickly reflected an investor view that the SNB was indeed serious, with their desired 1.20 floor remaining in place ever since.

    2. Mark,

      The Fed case for QE3 was largely based on boosting confidence (similar but not exactly the same as expectations). There were hopes for more direct effects on the real economy, but as yet little evidence that these hopes were fulfilled (as in the recent study by the SF Fed, link in this post).

      “So if, for example, investors believe that Fed QE actions imply a credible commitment to a higher level of nominal GDP growth, then market prices will reflect this, much of it instantly, which in turn affects lots of things.”

      I believe the Fed has been explicit that they are NOT targeting nominal GDP. That was proposed in 2010 & 2011, but rejected. See Yellen make the case:
      http://delong.typepad.com/sdj/2011/10/nominal-gdp-targeting-is-it-simply-the-re-animation-of-dead-tissue.html

      “For a good example of this look at the better than expected domestic demand in Japan that has arrived following investors believing the BoJ has manifested a new commitment to generating some positive inflation relative to what it’s done for the past 20 years.”

      I believe that is premature to say at this point. The first arrow of the “three arrows” — the BOJ to double the money supply in two years has reduced the value of the Yen, which will help exports (although perhaps push their trade deficit into there red).

      It is not yet clear that inflation expectations have changed, esp by looking at govt bond yields. Effect of the first arrow on domestic spending is even less clear, complicated by the second arrow (more govt spending) and the increased sales tax (which pulls forward purchases).

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