Seven years ago, when Prime Minister Shinzo Abe introduced his bold reflationary economic programme, he cited a medieval legend to explain how it would work. According to the tale, warlord Motonari Mori encouraged co-operation amongst his three sons by demonstrating the difficulty of snapping three arrows bound together.
Taking inspiration, Abe proposed to use the combined strength of his three policy arrows -monetary, fiscal and structural reforms – to re-energize the Japanese economy.
In reality, it was only in the first year that the three policy arrows were bundled together. The first arrow, monetary easing, was deployed on an enormous scale, as newly appointed Bank of Japan Governor Haruhiko Kuroda targeted central bank purchases of 80 trillion yen’s worth of government bonds per year and, later, included equity ETFs in his shopping basket.
The third arrow, structural reforms, produced some eye-catching results too – including rapid job growth amongst senior citizens and women, twenty million more tourists a year, an influx in foreign, mainly Asian workers and better corporate governance and dividend pay-outs.
What went missing after the initial phase of Abenomics was the second arrow, fiscal stimulus. Indeed, the government, under pressure from fiscal hawks in the Finance Ministry, hiked the consumption tax twice, in the spring of 2014 and the autumn of 2019. In both cases, there followed a severe retrenchment in consumer spending. Rather than combining the arrows, the government was using one to batter the other two.
As the chart shows, inflation expectations soared in the early phase of Abenomics, reaching 1.5%, a historically high level for Japanese inflation, then slumped as the fiscal squeeze, including various stealth taxes, strengthened its grip. Although nominal GDP returned to the growth track, there was little momentum in wages, prices and consumer confidence.
Fortunately, change is now in the air. Having deferred to the fiscal hawks one last time, the Abe administration has unveiled a fiscal package amounting to an enormous Yen 26 trillion yen, equivalent to 5% of GDP, focused on natural disaster prevention and other public works.
Japanese fiscal packages / supplementary budgets are never as large as promised. The “real water” (actual new spending, once double-counting and pre-planned outlays are removed) is usually half or less of the headline number. Even so, 40% of Yen 26 trillion would still make a significant impact.
If this proves insufficient to lift the economy, the likelihood is that more will be added later next year. Prime Minister Abe has his legacy to think about. Leaving office in 2021 with the economy sinking back into stagnation would tarnish his achievements and compromise his ability to influence the policies of his successors.
Furthermore, there is a final, highly controversial addition to Abe’s legacy that would cement his place in the history books – revision of Japan’s U.S.-imposed pacifist constitution. The relevant bill would need to pass both of Japan’s houses of parliament by a two thirds majority and, crucially, then be approved by a public referendum, which would be the first in Japanese history. Favourable economic conditions could be vital to getting the public onside.
Japan shift to fiscal policy was prefigured in a press conference given by BoJ Governor Kuroda in early November. His comment that “extra fiscal spending would be more effective than usual because the Bank of Japan could keep interest rates low through yield curve control” harked back to Abe’s original “three arrows” concept.
Kuroda is a Finance Ministry alumnus who had previously backed the tax hikes. It is often said that you can take the man out of the Finance Ministry, but you can never take the Finance Ministry out of the man. Kuroda’s new-found predilection for fiscal stimulus constitutes a Road-to-Damascus type conversion – and an indirect acknowledgement that monetary policy has reached the end of the line. In this, he is reflecting the shifting views of mainstream economists and central bank personnel overseas.
Will it work? Logically, there must be some magnitude of combined fiscal-monetary stimulus that has a significant effect on the real economy, inflation expectations and hence bond yields. If that were not the case, zero-yielding bond markets would be a perpetual free lunch. And indeed the early phase of Abenomics attests that new money injected into the real economy does have a real effect. What was lacking was the political will to persevere long enough.
Japan was hardly alone in succumbing to misplaced fears of a debt crisis and will not be alone in tilting to fiscal stimulus in the next few years. Policy-making in the wake of the global financial crisis of 2008 has been a process of trial-and-error in which several orthodoxies have been debunked. No doubt there will be more surprises to come.
One could be the end of “secular stagnation” and negative interest rates when Motonori Mori’s parable of the arrows is taken to heart and implemented with sufficient determination.
Motonori Mori