For today’s discussion, I would like to a little bit about what some next steps the Japan had taken for its famous Abenomics. Japanese government increased the sales-tax from 5% to 8% today. There is no surprise here since this was part of Abenomics plan announcement well back in 2012. But, I do want to do a half-time check on how Japan is doing with its plans and see whether it really had a significant effects in dimensions of economics.
It is hard to talk about Japanese economy without discussing what we call the lost decade–which had continued to reach two decades soon. I already have a blog post on the lost decade, so please go here for more details. Anyhow, the short version is that after 1990’s real estate bubble, Japan has seen very low inflation rates or even deflation–staggering growth and sometimes contracting up until recent years.
The biggest problem with low inflation is that the economy becomes highly vulnerable to exogenous supply shocks. The central bank also loses control over its monetary policy instruments. Even with the lowest interest rate of 0% since way back, negative inflation will bring real interest rate to positive side, resulting in net capital inflow and loss in net export. Just a glimpse on the graph below shows very high volatility in inflation at the lower end.
To make up for the big loss in exports and domestic private investments, the government had to spend a lot–and by that I mean A LOT (see graph below).
The debt-to-gdp ratio was at about 67% and now the owe more than twice of their income. One of the things that Japanese government did when they faced the real estate bubble deflating was to spend a lot. How did this work out for Japanese?
In terms of today’s goals, this is part of Abenomics’ goal. Although they are still heavily indebted, they wanted to do the extra mega-spending in fiscal policy and even looser monetary policy in order to override the deflation they were experiencing. The fiscal burden as you can see have been growing at a very fast pace. Japan also used very loose monetary policy, weakened the yen and made it stay there to restore some balance in the trades.
I want to give Abenomics some credit in restoring its economy. Although it went down 9% this year thus far, the Nikkei rose 57% last year. Also, it is on its way to reach the inflation target of 2% (now at 1.3%). On the other side, I think Japan is playing it very close to the line with continuing rise of the debt. Yes, they decided to raise the consumption sales-tax to 8%, but the condition for continued high confidence level is still very unpredictable. There has to be more of tax raise and other spending cuts in order to deal with the debt in the coming years, but it is still unclear whether the net effect of Abenomics would be positive.
Some pessimists like Gordon Chang is appalled by Japan’s approach and think Japan is undoubtedly going to default, causing massive financial crisis around the world. Other countries that are in international trade competition with Japan–countries like EU, South Korea, etc.–complain that it is very unjust for them to play the beggar-thy-neighbor approach.
I personally think that what Abe’s government did has no moral culpability per se. Ignoring the fact that Japan is still number 3 in terms of total nominal GDP, I think they used their last bullet in the gun to shoot for a comeback to their heydays growth level. They are running out of fiscal policy options with enough deficits in hand already. Monetary policy had been inoperative for many years and even more so now perhaps. To me it seems like Abenomics took the eat-a-lot-now-and-fast-later approach, and hopes that what they had eaten will last long after their fasting period. As Japan just begins their fasting period, they can only hope that their momentum will last