So far, Abe´s first two phases of Abenomics fiscal stimulus and monetary easing have coincided with an uptick in growth and stock-market sentiment. But the third arrow of Abenomics will be the trickiest to fire. Structural reform aimed at dismantling business inefficiencies hamper Japan´s global competitiveness..
Japan has suffered from long-lasting but mild deflation since the latter half of the 1990s, indicating the emergence of deflation. The rate of deflation measured by the headline consumer price index has been around 1% per year, which is much smaller than the rates observed in the USA during the Great Depression. However, the Japanese deflation has lasted for more than 15 years, clearly indicating that it is much more persistent than US deflation.
These factors, in turn, reflect various underlying structural features of the economy. This paper examines a long list of these structural features that may explain Japan’s chronic deflation, including central bank communication, weaker growth expectations coupled with declining potential growth or the lower natural rate of interest. Particular importance is placed on the question whether or not expected inflation has fallen into the negative territory.
The reason is that, as argued by Benhabib et al. (2001) and Bullard (2010), if expected inflation was indeed negative, then Japan may have found itself in a liquidity trap equilibrium, in which the central bank was prevented from escaping from such a trap by cutting its policy interest rate due to the zero lower bound on the nominal interest rate.
In responding to the emergence of deflation the Bank of Japan cut its policy interest rate several times until the rate finally reached the zero lowr bound (ZLB) in 1999, and this was followed by the introduction of quantitative easing (QE).
The liquidity trap is a very rare phenomenon, and the Japanese situation is only comparable with the US experience during the Great Depression. However, similar phenomena took place in the USA and European countries during the recent global financial crisis and the European sovereign debt crisis.
The rates of inflation in those countries were low even before the crisis happened, but declined substantially due to diminishing aggregate demand, and sometimes fell below the target level of inflation, which was somewhere around 2%. Here too, in responding, the Federal Reserve cut its policy rate several times until the policy rate reached the zero bound, and then moved on to the adoption of quantitative easing in November 2008.
Similarly, quantitative easing has been adopted by the European Central Bank since May 2009 and by the Bank of England since March 2009. Unprecedentedly, large-scale purchases of assets by the central banks in those countries contributed to the recovery from the crisis, but also produced harmful side effects, including massive, hard-to-control money inflows into emerging market economies.
More recently, the BoJ set a 2% inflation target in January 2013, and announced in April 2013 that it would seek to achieve this inflation target within two years, by doubling the base money by March 2015.
Prime Minister Shinzo Abe, has embarked on a plan to kick start Japan´s long sluggish economy. He also wanted to his nation to be strong and respected. As Japans new prime minister he he want to change the pacifist constitution to allow Japan to be able to use force if necessary. And he has been as belligerent as China´s leaders over islands that both sides claim.
Abe had been deeply influeced by his grandfather, Nobusuke Kishi who was prime minister in the late 1950s. After World War II Kishi was arrested as a suspected war criminal but never charged. He saw the “peace constitution” as a humiliation imposed on Japan after its devastating defeat by the US. When Abe became politician two decades ago, he had been questioning the wisdom of upholding the Art. 9 of the constitution. It’s quite unlikely that we would see the return of a revisionist Japan, as the “rules have been carefully crafted to prohibit such adventures”.
What Abe has achieved today would make his grandfather very proud, as he has realised his dream. But in truth, the real danger he still poses is not military but monetary. When Mr Abe first announced his economic policy package that came to be known as Abenomics, observers felt it held the potential to lift Japan out of the economic slump it had been stuck in for the past two decades. He has demanded that the Bank of Japan (BOJ) generate more cash to end corrosive deflation, and he has vowed to spark growth with massive government spending on public works.
About 18 months have elapsed since Prime Minister Shinzo Abe announced his economic revival plan to lift Japan out of decades-long deflation and low growth.
Arrows one and two – monetary and fiscal stimulus – are in their efforts to pull Japan out of its economic funk. underlying momentum is strengthening, but greater structural and fiscal reforms are still needed for growth to be sustained.
In anticipation of the Abe administration’s imminent announcement of a revised growth strategy (the third arrow of Abenomics), there has been renewed interest in how Abenomics will address Japan’s future economic problems as well as those in the present, and how that will affect neighboring economies in Asia.
Brookings Institution, Center for East Asia Policy Studies hosted Dr. Naoyuki Yoshino, dean of the Asian Development Bank Institute and contributor to the revised growth strategy, for a presentation on the three arrows of Abenomics, the revised growth strategy and the current state of the Japanese economy.
So far, “Abenomics”—as his plan has been dubbed—has delivered a significant pickup in growth and raised inflation. However, private investment has yet to recover decisively and wage growth, a key yardstick to gauge success in re-inflating the economy, has remained modest.
Aggressive monetary easing: Efforts by the Bank of Japan’s Quantitative and Qualitative Monetary Easing (QQME) have included adopting a 2 percent inflation target and aiming to double the monetary base in about two years to 50 percent of GDP through large-scale asset purchases. The goal of these policies has been to eliminate defl ation and move the economy onto a path of sustained positive infl ation.
Judged against this objective, the policy efforts have been largely successful in raising inflation and inflation expectations. The strategy has involved shortterm stimulus combined with a path to medium-term fiscal consolidation.
- GDP growth accelerated sharply in the immediate aftermath of Abenomics, rising to just over 4 percent in the first half of 2013—underpinned by stronger sentiment and wealth effects from soaring equity prices, and stronger exports benefiting from a weaker yen. However, recent data hint that this economic momentum may be losing steam as fiscal stimulus winds down, and the effects of higher stock prices and a weaker currency start to fade.
Japan saw a record trade deficit in January, while exports by volume fell compared with January of the previous year. While an ever-weakening currency might stimulate short-term growth, it risks promoting a self-fulfilling cycle of yen weakness, greater trade deficits, and further depreciation. In a country with an aging and shrinking population, real long-term growth can only be realized through improved productivity.
QE reduces companies’ cost of debt and supports their share prices without requiring CEOs to make productive investments. We have seen a similar dynamic at work the U.S. – the stock market has reached a record high, but capex and hiring has lagged woefully behind. To stimulate productive investment, Japan must revamp the second arrow of Abenomics and focus on tax incentives rather than government spending.
What´s needed is not more spending but more reform. Higher health care spending has the potential to further weaken the fiscal position and debt dynamics. Without additional reforms Japan risks falling back into lower growth and deflation, a further deterioration in the fiscal situation, and an overreliance on monetary stimulus with negative consequences for the region.
In light of this, IMF analysis suggested , the second consumption tax hike should proceed as planned without resorting to multiple rates. A further priority should now be to outline a detailed mediumterm consolidation plan, based on both revenue and spending measures. Policy measures could include further increases to the consumption tax as well as pension and health care reforms.
A successful launch of a broad range of structural reforms would reignite investment and help sustain growth. Investment could be supported by tax reforms, market deregulation, and corporate governance reforms.
Supply-side reforms to raise private investment and potential growth will ensure that the economic recovery is sustained, even as fiscal and monetary support is scaled back
The new framework legislation on special zones also needs to be fleshed out. Measures should also be taken to reduce labor market duality and make non-regular workers more productive, encourage female employment, and relax immigration requirements to address labor shortages. Unconventional labor policies— including wage growth incentives or a hike in minimum wages—could also be useful in catalyzing a faster pace of nominal wage growth.
These kinds of measures should prove more effective, and safer, than fiscal stimulus. Japan’s government debts are already more than twice its GDP, and continually tapping the bond market and spending the proceeds unproductively will ultimately prove problematic.
Without more sustainable growth-generating measures, Japan risks an “Abegeddon” scenario – entrenched stagflation that prompts outflows of capital and a run on the government bond market.
The third arrow of Abenomics, reform, also requires redirection. First, Japan needs to ensure its businesses use its people properly. To do this it will need to address a rigidity that has led to the development of a ‘dual’ labor market. Around 40 percent of workers are now deemed ‘temporary,’ in jobs which provide low pay, a lack of social insurance, and little opportunity to develop skills.
If Japan executes on these kinds of reforms, it may still need to lean on the Bank of Japan to boost growth. But it would be doing so from a much stronger position.
Countries operating in competitive markets need to make their products as well, and as efficiently, as possible before slashing prices. Disciplined approach to economic policy and sustained commitment. True key growth strategy to success.