Japanese Prime Minister Shinzo Abe’s program for his country’s economic recovery has led to a surge in domestic confidence. However, to what extent can “Abenomics” claim credit?
Interestingly, a closer look at Japan’s performance over the past decade suggests little reason for persistent bearish sentiment. Indeed, in terms of growth of output per employed worker, Japan has done quite well since the turn of the century. With a shrinking labor force, the standard estimate for Japan last year — that is, before Abenomics — had output per employed worker growing by 3.08 percent year-on-year. That is considerably more robust than in the US, where output per worker grew by just 0.37 percent last year, and much stronger than in Germany, where it shrank by 0.25 percent.
Nonetheless, as many Japanese rightly sense, Abenomics can only help the country’s recovery. Abe is doing what many economists (including me) have been calling for in the US and Europe: a comprehensive program entailing monetary, fiscal and structural policies. Abe likens this approach to holding three arrows — taken alone, each can be bent; taken together, none can.
New Bank of Japan Governor Haruhiko Kuroda comes with a wealth of experience gained in the Japanese Ministry of Finance and as a former President of the Asian Development Bank.
During the East Asia financial crisis of the late 1990s, he saw firsthand the failure of the conventional wisdom pushed by the US Department of the Treasury and the IMF. Not wedded to central bankers’ obsolete doctrines, he has made a commitment to reverse Japan’s chronic deflation, setting an inflation target of 2 percent.
Deflation increases the real (inflation-adjusted) debt burden, as well as the real interest rate. Though there is little evidence of the importance of small changes in real interest rates, the effect of even mild deflation on real debt, year after year, can be significant.
Kuroda’s stance has already weakened the yen’s exchange rate, making Japanese goods more competitive. This simply reflects the reality of monetary policy interdependence: If the US Federal Reserve’s policy of so-called quantitative easing weakens the dollar, others have to respond to prevent undue appreciation of their currencies. Someday, we might achieve closer global monetary-policy coordination; however, for now it made sense for Japan to respond, albeit belatedly, to developments elsewhere.
Monetary policy would have been more effective in the US had more attention been devoted to credit blockages — for example, many homeowners’ refinancing problems, even at lower interest rates, or small and medium-size enterprises’ lack of access to financing. Japan’s monetary policy, one hopes, will focus on such critical issues.
However, Abe has two more arrows in his policy quiver. Critics who argue that fiscal stimulus in Japan failed in the past — leading only to squandered investment in useless infrastructure — make two mistakes. First, there is the counterfactual case: How would Japan’s economy have performed in the absence of fiscal stimulus? Given the magnitude of the contraction in credit supply following the financial crisis of the late 1990s, it is no surprise that government spending failed to restore growth. Matters would have been much worse without the spending; as it was, unemployment never surpassed 5.8 percent, and, in throes of the global financial crisis, it peaked at 5.5 percent. Second, anyone visiting Japan recognizes the benefits of its infrastructure investments (the US could learn a valuable lesson here).