How Effective Will “Abenomics” Be?

Hopes are growing that Abe Shinzō, Japan’s new prime minister, will be able to restore the health of the Japanese economy by means of his “Abenomics.”

The yen finally began to weaken and stock prices surged late in 2012 when the decision to dissolve the House of Representatives was reached, signaling the markets expectations of Abe’s economic policies. The Liberal Democratic Party won a stunning victory in the ensuing general election on December 16, and Abe Shinzō, the LDP’s president, became prime minister for the second time after a brief term in 2006–7. On January 7, 2013, the three leading business organizations—Keidanren (Japan Business Federation), Keizai Dōyūkai (Japan Association of Corporate Executives), and Japan Chamber of Commerce and Industry—invited Abe to their New Year’s Party, which attracted a crowd of some 1,700 business leaders, up by more than 100 people from last year’s party. But will the Abe administration be able to rescue Japan from the deflation it has been struggling with for almost two decades? At this point, nobody can say.

Abe’s Insistence on a 2% Inflation Target

Abenomics is “three arrows” of policy, consisting of bold monetary relaxation, flexible application of fiscal stimulus, and a growth strategy for arousing private investment.

The first goal Abe set was an inflation target. He delivered a plainly stated message that once he became prime minister, he would demand that an extremely loose monetary policy be kept in place as long as necessary for the target’s attainment. Recognizing that it will take some time for expectations of inflation to set in, because the market must first sense that business is turning up, he also got to work on plans to have the public sector lead the way to an upturn. Fiscal stimulus is to be aggressively applied in a supplementary budget for fiscal 2012 (April 2012 to March 2013) and in the fiscal 2013 budget, channeling extra spending into public works and other such projects. Abe has also scheduled the unveiling of a new growth strategy, which will aim to whet the private sector’s appetite for investment, in June 2013. Once businesses became more bullish, he believes, the private sector will take over from the public sector as the main growth engine. This scenario has been dubbed a “three-stage rocket” for lifting the economy into orbit, reversing the deflationary trend in the process.

Above all, Abe has laid heavy emphasis on the importance of drastic monetary relaxation. During the campaign for the December 2012 House of Representatives election, he had the LDP put a promise of achieving price increases at a 2% rate into its platform, and he revealed that he was considering the use of a policy accord between the Bank of Japan and the government to ensure they acted in unison. After the election, in a television interview just before he was designated prime minister, he threatened that if the BOJ balked at setting a 2% inflation target, “we’ll amend the BOJ law and get the target set by forging a policy accord.”

The Failure to Vanquish Deflation in 2006 and 2007

Abe’s fervent desire for an even looser monetary policy was born of a series of bitter experiences beginning in March 2006, when he was serving as chief cabinet secretary under Prime Minister Koizumi Jun’ichirō. Pointing out that there had been no change in the perception that gradual deflation was still in progress, he argued that the government and the central bank, acting hand in hand, still needed to do everything possible to stop prices from falling. But just at that point the BOJ decided the time had come to terminate its policy of “quantitative easing,” which it had been pursuing since March 2001.

Shortly thereafter, in July 2006, the BOJ also lifted its “zero interest rate policy.” Then, in February 2007, during Abe’s first term as prime minister, the central bank embarked on a course of raising interest rates. One of Abe’s confidants says, “the prime minister believes that it should have been possible to arrest deflation back then if only the existing monetary policy had been left in place a little longer.”

Monetary Policy Alone Will Not Be Enough

If Japan goes forward with aggressive monetary easing, can we expect an economic revival to follow? Unfortunately, there is no guarantee of that. The problem is that changes in economic conditions always have both good and bad effects. Consider, for instance, the yen’s recent weakening, which is thought to be a result of expectations of looser monetary policy. For the time being, it will give a boost to the nation’s exporters by enabling them to mark prices down. At the same time, however, it will also increase import prices to the extent that the yen falls. With nuclear power now out of service, imports of oil and liquefied natural gas are on the increase, and their higher prices will eventually boomerang back on manufacturers in the form of larger electricity bills.

More than anything else, we must recognize once again that deflation cannot be brought to a halt by monetary policy alone. The other two prongs of Abenomics—fiscal stimulus and a growth strategy—must also be used to prod prices in the upward direction. Instead of placing full responsibility for the battle against deflation in the hands of the BOJ, the government must suit up for battle itself. The accord these two actors should establish should make them the two wheels of a cart.