Can Abenomics really save Japan?

The Bank of Japan kicked off its stimulus programme yesterday. But the experts are divided over whether it will restore growth says Ben Chu

Japanese macroeconomic statistics are a thing of wonder – and not in a good way. The country's total GDP output, in cash terms, is no higher than it was in 1990, thanks to a combination of weak growth and rampant deflation over two decades.

The Nikkei 225 stock market is still well below the peak it achieved in the late 1980s at the height of the equities bubble. Despite net national debt soaring to 135 per cent of GDP in recent years, 10-year Japanese debt yields just 0.5 per cent interest. These are figures that still leave economists open-mouthed.

But the Japanese are sick of being a wonder of economics. The new government of Prime Minister Shinzo Abe, who won office at the end last year, has pledged to end the country's economic funk. Since coming to power, Mr Abe has announced a significant fiscal stimulus to boost demand, along with a programme of structural reforms to increase the economy's growth capacity.

But it is on monetary policy where the new Abe administration has been most radical. It has doubled the central bank's inflation target to 2 per cent and installed the anti-deflation activist Haruhiko Kuroda at the helm of the traditionally conservative monetary authority.

Mr Kuroda pledged last week to double the country's monetary base within two years by buying Japanese government bonds. And the Bank of Japan kicked that off yesterday with $1.2bn (£787m) in bond purchases.

Markets were taken by surprise. They hadn't expected such swift action from the new regime. The yen fell to a four-year low against the US dollar and the Japanese Nikkei index jumped.

"This has really shaken up many people's attitudes," said Andrew Wilkinson of the New York brokerage Miller Tabak. "It feels like it's gathered a whole new momentum behind it, as the doubters have joined the bandwagon and it's becoming a self-fulfilling prophecy."

So the markets are starting to believe. But should the rest of us? Can "Abenomics" really work?

Theory says yes. By boosting the money supply on a sufficiently large scale for a sufficiently prolonged period, the authorities should be able to increase levels of spending in the domestic economy. This should, finally, eradicate the deflation that has sapped Japanese consumption and investors' spirits for these past two decades.

If Japanese consumers see prices rising they will start to spend, rather than delaying their purchases. Businesses, seeing the possibility of profits, will invest. This will create a virtuous circle of higher growth and the erosion of both public and private debt piles in real terms. There is no reason for a country that prints its own money to suffer from prolonged falling prices since there are no limits to the amount of money the Japanese government can create in order to drive up prices.

There are, however, sceptics. Tim Morgan of the money broker Tullett Prebon warns that the activism could spark a rise in Japanese interest rates.

"Injecting inflation may indeed devalue historic debt," he wrote in a blog post yesterday, "but this will be achieved at a high price if, as a result, market interest rates rise, the willingness of the population to save declines, and energy costs surge."

Stephen King, the chief economist of HSBC, has argued that Japan is in a structural economic decline that Mr Abe's monetary activism could well fail to reverse.

"Offshoring, ageing, the unproductive use of women in the workforce and an acutely cautious attitude towards immigration have all played their part in constraining Japanese growth during its two lost decades," he wrote in the Financial Times. " A wave of the monetary magic wand cannot fix those problems."

Yet the economists who know most about deflation and Japan say otherwise. They argue that Abenomics can work provided the programme is followed through and that policymakers do not withdraw the stimulus prematurely, as they have in the past.

Richard Koo, the Japanese economist who coined the phrase "balance sheet recession" to describe his country's deflationary malaise, thinks the combined three pillars of Abenomics – fiscal stimulus, monetary stimulus, and supply side reform – "make sense".

Adam Posen, a Japan expert who until last summer was a member of the Bank of England's Monetary Policy Committee, also believes the Bank of Japan is finally doing the right thing (although he is sceptical of the wisdom of Mr Abe's fiscal policies).

And what about the spill-over effects of this Japanese revolution on the rest of the world? There has been much talk in recent months about an outbreak of currency wars and beggar-thy-neighbour competitive devaluations. Many suspect that one of the undeclared objectives of Abenomics is to reduce the value of the yen and give Japanese exporters a fillip.

However, Ben Bernanke, the chairman of the Federal Reserve and the pre-eminent scholar of the 1930s Great Depression, firmly dismissed those concerns at a recent speech at the London School of Economics.

"The advanced industrial economies are currently pursuing appropriately expansionary policies to help support recovery and price stability in their own countries," he told the audience. "As the modern literature on the Great Depression demonstrates, these policies confer net benefits on the world economy as a whole and should not be confused with zero- or negative-sum policies of trade diversion. In fact, the simultaneous use by several countries of accommodative policy can be mutually reinforcing to the benefit of all."

That last point emphasises why Japan matters to the rest of us. Our own economies have been suffering from stagnation and weak growth since the 2008 global financial crisis. American unemployment is still well above historic levels and last week job growth showed an alarming slowdown. The UK is already halfway through a lost decade of economic output.

We might be clamouring for our own version of Abenomics one day if things don't turn around.

Comments