Why Abenomics is bound to disappoint Japan
Signs are that deflation can be beaten but hopes for faster growth are optimistic
Yokohama and Mount Fuji: “Given its demography, Japan would do well to attain growth of 1-1.5 per cent a year. The country will be unable to combine economic dynamism with fiscal consolidation without a rise in consumption’s share in GDP.” Photograph: Getty Images
The predominant concern of Shinzo Abe, Japan’s prime minister, is with the decline of his country’s economy relative to China’s. This explains “Abenomics”, which is aimed at economic revitalisation. Can it succeed? Yes – but only in part. It should be possible to end deflation. But a big upsurge in economic growth is unlikely.
Abenomics consists of “three arrows”. The first is a monetary policy aimed at eliminating deflation. The second is a flexible fiscal policy, aimed at supporting the Japanese economy in the short run and at fiscal stability in the long run. The third is structural reform, aimed at raising investment and trend growth.
Of the three arrows, the first is most likely to hit the target. In January the Bank of Japan (BoJ) adopted an explicit target of 2 per cent consumer price inflation. But it was only after the appointment of Haruhiko Kuroda, an outsider, as governor that a new approach was born. Under his leadership, the bank announced its ambitious programme of “quantitative and qualitative easing”, or QQE.
The aim is to deliver the inflation target “at the earliest possible time, with a time horizon of about two years”. The central bank committed to doubling its holdings of Japanese government bonds over two years and more than doubling the average maturity of those holdings. Christina Romer, former chair of the US council of economic advisers, hailed this as a “regime shift”, comparable to the US decision to go off the gold standard in 1933.
As Mr Kuroda has argued, the new policy is intended to affect the economy through reductions in interest rates, shifts towards holding riskier assets and higher inflation expectations. “We are half way,” Mr Kuroda said. “The latest statistics show that the inflation rate has reached 0.9 per cent. But there is still a long way to go.”
Case for optimism
A case can be made for optimism. First, evidence from bond markets and consumer surveys suggests inflation expectations are rising. Second, excess capacity is probably very small: the BoJ judges it is only 1.5 per cent of potential output, which is supported by the fact that unemployment is now about 4 per cent. Third, the economy is forecast to grow twice as fast as potential output over the next two years. That would eliminate excess capacity. Finally, the BoJ has made clear its determination to do whatever is needed to achieve inflation. A central bank can always reduce the value of the money it creates if it wants to. The risk is that, instead of stabilising at 2 per cent, inflation expectations rise far higher, forcing the BoJ to tighten.
Mr Kuroda also argues that positive expected inflation would promote economic activity. Real interest rates would be negative, encouraging households and companies to spend. If investment rose, so would the sustainable rate of economic growth. Moreover, if the private sector’s financial surplus (at 11 per cent of GDP last year) was to fall sharply, the fiscal deficit could dwindle without damaging economic activity.
In these ways, then, the BoJ’s new strategy might promote a degree of economic revitalisation, though it also risks destabilising expectations of deflation, without reanchoring them at 2 per cent inflation. But monetary policy cannot eliminate the structural imbalances inside the economy or do much to raise underlying growth.