The bold policies promised by Japan’s new government look ill-suited to reverse a relative decline that has turned a leading actor on the world economic stage into a bit-part player in less than a generation.
With Japan mired in its fourth recession since 2000, incoming Japanese prime minister Shinzo Abe campaigned on a platform of “unlimited” monetary easing by the Bank of Japan (BOJ) as well as a splurge in public-works spending.
The yen has already started to weaken and could well decline further if the central bank succumbs to political pressure to set a formal inflation target. That would bring relief to Japanese exporters and, at the margin, provide a cyclical lift to growth.
“We’re already in a world with lots of excess liquidity in the system from the big central banks, but if the BOJ were to add to that, then it would be another positive for risky assets. This is an additional tap that is, potentially at least, being turned on,” said Philip Poole, global head of investment strategy at HSBC Global Asset Management in London.
Yet if loose fiscal and monetary policy were a cure-all, Japan’s economy would not be in the sick ward in the first place.
The government is running a budget deficit of about 10 percent of gross domestic product and its gross debt has risen from less than 68 percent of GDP in 1990 to more than 235 percent now.
And the Bank of Japan pioneered unconventional monetary policies a decade ago once it had reduced interest rates close to zero, introducing asset-purchase programs that have since been copied by other central banks, notably the US Federal Reserve and the Bank of England.
Julian Jessop, chief international economist with Capital Economics, a London consultancy, said investors could be getting their hopes too high. After all, the BOJ has failed to reach its inflation “goal” of 1 percent, never mind the more ambitious “target” of 2 percent eyed by Abe.
Moreover, the Liberal Democratic Party, which Abe heads, was in government for much of the past two decades since Japan’s property and share-price bubble burst, crippling its banks and ushering in permanent low-level deflation.
Tokyo’s policy response matters not only because Japan remains the world’s third-largest economy. Its experience is being closely watched by other countries that are also drowning in government debt, have already driven interest rates down to zero and will soon join Japan in having fast-ageing populations.
Growth in Japan’s working-age population peaked in the late 1980s, just before its asset bubble burst, and turned negative at the turn of the century.
Not surprisingly, Japan’s capital stock has mirrored the trend because businesses cannot justify making new investments to serve a shrinking pool of consumers.
With companies’ return on capital almost zero, monetary policy becomes as effective as pushing on a piece of string, according to Ryutaro Kono, an economist with BNP Paribas in Tokyo.
Indeed, even the existing capital stock is excessive in such an environment: Net private investment has been negative in Japan since the mid-1990s as firms have written off old plants and equipment.
The slump in capital spending has freed up savings to help finance the government’s big budget deficit, but at some point the dearth of investment will push Japan’s trend growth rate, now no higher than 0.5 percent, below zero. That would depress tax revenues and touch off a long-feared fiscal meltdown, perhaps early next decade, Kono wrote in a recent paper.