Japan looked like the model for economic revival. Growth was back on track. The stock market was surging. Inflation, which had eluded Japan for decades, was even returning.
However, Japan’s grand economic experiment, a combination of fiscal discipline and monetary stimulus, is collapsing. On Monday, the country unexpectedly fell into recession, a downturn that has painful implications for the rest of the world.
Japan’s unorthodox strategy was supposed to offer a road map for other troubled economies, notably Europe. Fiscal belt-tightening and tax increases, while leaning on the central bank to pump money into the economy, was expected to help overcome a malaise.
However, the formula has failed to ignite a meaningful recovery in Japan — and has even added to its woes. Europe must now decide whether to follow Japan’s lead by injecting more money into the economy, as the region’s central bank considers a similarly aggressive bond-buying campaign known as quantitative easing. And the US, which just ended its own six-year stimulus effort, does not offer much of a cushion should other economies stumble further.
“The United States is about the only growth beacon in the global economy right now, and that is not a very nice place to be,” said Jacob Funk Kirkegaard, an economist at the Peterson Institute for International Economics in Washington. “An American growth pickup is positive, but it looks like the rest of the world is again going to be relying on the US as a consumer of last resort.”
Japanese Prime Minister Shinzo Abe won power two years ago on a promise to pull the economy out of nearly two decades of corrosive wage and price declines. The initial response of both Japanese consumers and global investors was ebullient: The economy surged during the first few months of his administration early last year, and Japanese stock prices soared.
Abe’s program, called Abenomics, at first relied on a one-two punch of government spending and financial support from the Bank of Japan, the country’s central bank. The bank sharply increased its program of buying government bonds and other assets, similar to the stimulus effort recently ended by the US Federal Reserve.
In some ways, Japan has been more aggressive than the US. Its bond buying program, which was expanded last month, is now bigger relative to the size of its economy than the Fed’s was at its peak.
However, much of the enthusiasm for Abenomics has evaporated.
Some economists blame a lack of action by Abe’s government in areas beyond pump-priming stimulus, such as deregulation and trade.
A turn toward tighter fiscal policy has taken the majority of the blame.
Government data released on Monday showed that the country unexpectedly fell into recession in the third quarter, hampered by rising sales taxes that have discouraged consumers from spending.
“What Japan shows is that if you have longstanding economic stagnation, having an aggressive monetary policy and even sizable fiscal reform is not going to work without deep-rooted structural reform,” Kirkegaard said. “The experience of Japan must be at the top of the minds of European leaders.”
High on the agenda is whether Europe should pursue large-scale purchases of government bonds, so-called quantitative easing.
The European Central Bank recently said it was prepared to take additional steps to revive the struggling economy, by lending more to banks and buying bonds backed by mortgages and other assets.
Critics say the bank has not acted nearly aggressively enough to help revive growth, which has essentially stagnated.
The similarities between the two places is strong, which has prompted some economists to wonder whether Europe will turn into another Japan.
Europe and Japan have stuck with various versions of austerity, neither pushing ahead with deep-seated changes to their economy that analysts say are needed to revive long-term growth. Europe is also increasingly facing down the Japan-like specter of deflation as a recovery lags.
The political debate is also developing along the same lines.
A number of countries, led by France and Italy, recently balked at EU requirements to doggedly adhere to fiscal targets and eschew stimulus spending that some economists say is critical.
Some economists say that Japan’s situation only adds to the argument that fiscal belt-tightening, while sometimes needed to mend a country’s finances, hurts growth when an economy is in decline.
European politicians now widely blame austerity policies for delaying a return to growth, but German Chancellor Angela Merkel is wary of loosening requirements for fiscal discipline after runaway debt levels and high deficits helped generate the eurozone debt crisis. The region’s leaders are scheduled to meet early next month to discuss further strategies for growth.
“The main implication is we are beginning to see what it might look like in Europe if we go down that road,” Conference Board chief economist Bart van Ark said, referring to Japan’s recession.
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