Japanese economy in need of bold and urgent action
Serious Money:Japanese asset prices have jumped on to investors’ radar screens of late; the return of the Liberal Democratic Party (LDP) to power late last year has sparked hopes that the new leadership might match their pre-election rhetoric with actions to help bring years of economic stagnation to an end.
The Diet was dissolved last November, and the LDP, under Shinzo Abe, secured a landslide election victory four weeks later, as voters expressed their disillusionment with the Democratic Party of Japan and backed the LDP’s promises to wage a determined battle against deflation through aggressive monetary easing, alongside flexible fiscal management.
Abe harangued the Bank of Japan (BOJ) during the election campaign, arguing that the monetary authority has been far too timid in its efforts to combat long-term deflation. Further, he threatened to amend the 1998 Bank of Japan Act if the central bank does not soon accede to a 2 per cent inflation target, and after he assumed the post of prime minister, he taunted the monetary policymaker with the words: “There is no future for a country that abandons hope for growth.”
The need for bold action on both fiscal and monetary fronts is not difficult to understand in the context of an economy that has been in relative decline for more than two decades, and recently slipped into its fourth recession since 2000. Real GDP growth averaged more than 4 per cent a year from 1974 to 1990, but has averaged barely half a per cent a year ever since, as the economy continues to languish in the aftermath of the bursting of a joint asset and credit bubble more than 20 years ago.
The damage inflicted upon private sector balance sheets by the implosion of the bubble led to a pronounced and protracted deleveraging that saw private sector savings surge relative to investment. The resulting deflationary impulse has seen the GDP deflator drop almost 18 per cent from its 1994 peak, while nominal GDP is almost 10 per cent below the peak in the fourth quarter of 1997.
The BOJ had cut policy rates to near-zero by 1995, and shifted to a zero-interest-rate-policy (ZIRP) in the spring of 1999, which was followed by the adoption of a quantitative easing policy that persisted from 2001 to 2006. However, the unconventional policy failed to prevent deflation from taking hold and the resulting strong demand for precautionary money balances ensured that the private sector’s financial surplus persisted at high levels.
High private sector savings relative to investment contributed to large fiscal deficits that have seen the public sector debt ratio jump to close to 240 per cent of GDP, a level that is in a class of its own – even compared to the euro zone’s troubled periphery. Fortunately, the preference for low-risk assets in a deflationary environment ensured the growing government debt could be financed by private sector savings at a low interest cost. Looking forward however, projections of future fiscal deficits and household savings rates as the population ages, suggest that it is only a matter of time before the Japanese are forced to tap foreign capital markets, which are far less likely to provide funding at today’s historically low rates.