After Shinzo Abe took office as the Prime Minister of Japan in December 26, 2012, there has been much excitement over what is called the Abenomics. To end Japan’s long lasting deflation and sluggish, if not negative, growth over the past 15 years or so, Abe took radical measures to revive the economy. These include quantitative easing, devaluations of yen and large investments in public infrastructure programs. Abe’s effort received highlight around the world as it showed impressive results thus far.
Japan’s concern for their economy started in 1989 when the real estate bubble bursted. Following the 1970’s economic boom in Japan, Japanese seized the opportunity of low interest rate with high liquidity in the market to invest heavily in real estate as well as stocks in both domestic and foreign investments. However, when the Bank of Japan realized that the hype over this excessive investment was not sustainable, it raised the interest rate sharply, bursting the bubble. Unpayable debt accumulated and stock market plummeted along with asset prices in real estate. In order to stabilize the economy, the central bank made big volumes of loans, government injected extra money into the economy and a large restructuring of debt took place. Many banks could not get extra loan even with very low (or lower bound zero) interest rate due to bad credit. Stagnation took place and this was the start of what is called the lost decade.
Howe did Abe fix this problem? As mentioned above, large government spending, deliberate depreciation of yen and aggressive quantitative easing. The depreciation of yen especially played a major role as it lead to a large export boom. The Nikkei, while still under 58% of 1989 level, gained 57% in 2013 (http://articles.economictimes.indiatimes.com/2014-01-12/news/46113491_1_core-consumer-price-index-nikkei-abenomics).
The problem is then, how is Japan going to pay for all these? According to January 13, 2013 news, Japan hit a record current-account deficit as imports climbed back up. The article says, “Weakness in the yen and extra demand for energy because of nuclear-plant shutdowns are driving up Japan’s import bill, highlighting drags on the recovery that will also include a sales-tax increase in April. A longer-term risk for the nation is any shift to a sustained deficit that would undermine investor confidence in Japanese government debt” However, the consensus among Japanese economist is that the “the deficit should start to gradually shrink on the back of a global recovery” (http://www.bloomberg.com/news/2014-01-14/japan-posts-record-current-account-deficit-as-import-costs-swell.html).
In addition, economists like Paul Krugman fears that the scheduled rise in consumption tax from 8% to 10% in 2014 will discourage spending, hurting efforts to climb out of deflation. With deflation effect still in place, this increase of 2% will hurt more in real terms (http://krugman.blogs.nytimes.com/2013/06/10/abenomics-and-interest-rates-a-finger-exercise-wonkish/?_r=0). With long history of deflation in the past two decades with very sluggish growth, this rise in tax could act as a sharp break on the upward trend.
The tradeoff between deficit growth and economic expansion must be carefully reviewed. And only time will tell how Japan will react to the new roller-coaster ride the Japanese economy has gone through in the past year.