Author: Hugh Patrick, Columbia University
What a dramatic sea change in Japan from late summer 2012 to late summer 2013! More in the politics than in the economy, but even more in the mood, sentiment, expectations, and hopes of consumers and businesses. The selection of Tokyo for the 2020 Olympics is a welcome further boost to Japanese spirits.
After six years of weak governments reflected in annual changes of prime minister and exacerbated by split control of the two houses of the Diet, Japanese were sick and tired of it all. Voters were eager to support a government committed to economic change. Now Shinzo Abe’s Liberal Democratic Party (LDP) seems set to govern for at least three more years until the next upper house elections December 2016 and probably beyond.
Abe has the political power. And he has strongly stated his political will to achieve three major economic policy objectives: end deflation, achieve stable growth and bring debt under control.
To achieve these, what has been branded ‘Abenomics’ will use monetary stimulus, near-term fiscal stimulus to be followed by fiscal consolidation, plus deregulation and structural reform to achieve good growth. These are termed the ‘three arrows of Abenomics’, reflecting the Japanese proverb that while one arrow can be broken, three arrows together cannot. But is one weaker than the others? Which is the most important? In a series of articles, I will examine the individual strength of each arrow.
Let’s start with Abe’s determination to end deflation.
Abe clearly indicated, even before being elected prime minister, that he wanted the Bank of Japan (BOJ) to pursue a policy of further monetary easing even though, as in the United States, interest rates were already extraordinarily low. To that end, the Diet appointed Haruhiko Kuroda as governor and Kikuo Iwata and Hiroshi Nakaso as deputy governors. They took office on 20 March. On 4 April the BOJ announced a new dramatic easing policy far stronger than I and most others expected.
Moreover, Governor Kuroda stated the BOJ would continue extraordinary monetary easing until deflation was ended. He set an ambitious target of a 2 per cent annual increase in the CPI within two years.
It is important to understand that this target and some CPI forecasts are net of the effect of the 3 per cent increase in the consumption tax, which is projected to add about 1.5 to 2 per cent to the CPI in fiscal 2014.
It takes time for monetary policy to affect prices. Achieving the CPI target within two years will be difficult, but that is not as important as conquering Japanese deflationary expectations and sustaining expectations that the CPI will continue to rise modestly over the longer term.
The 0.4 per cent CPI increase in June 2013,0.7 per cent in July, and 0.8 percent in August suggest that monetary policy is succeeding. But almost all of those increases were due to cost-push rather than demand-pull factors, notably the rise in prices of electricity and imports. In August the Cabinet Office projected a 0.5 per cent CPI rise this fiscal year. Including the consumption tax increase, it estimates that in fiscal 2014 the CPI will rise 3.3 per cent, but excluding the tax effect the increase will be 1.2 per cent. These are optimistic projections, above those of private-sector analysts. It is still too early to believe that deflation has halted.
Asset prices have also responded to Abenomics. Foreign institutional short-term traders are significant players in Japanese stock and foreign exchange markets, so market indicators do not always well reflect Japanese investor expectations. But it is worth noting that after the December 2012 election was announced, traders, particularly foreign hedge funds, decided that the stock market was too low and the yen too strong. The Topix stock index soared more than 75 per cent from its 12 November 2012 close to a 22 May 2013 intraday peak of 1284, and the yen depreciated 30 per cent to 103.52 yen to the dollar. Although it has since fallen somewhat, on 30 August the Topix stock index was still up 55 per cent from last November.
After having declined since 2008, urban land prices seem to have turned the corner and begun a slight rise. The government’s August quarterly nationwide survey reported that prices had risen in 99 of the 150 survey points. This is good news, since stabilisation of land prices is key in overcoming deflationary expectations.
Fiscal stimulus to support demand-based recovery has proceeded in tandem with monetary stimulus. In March, the government passed a major supplementary budget of ¥10.3 trillion (then about US$110 billion). That has sustained increased government public works spending, as have ongoing Tohoku reconstruction expenditures and the fiscal 2013 government budget deficit of 9.3 per cent of GDP.
I think that the signs are good. Deflation probably will be brought to an end over the coming year. Achieving the 2 per cent CPI growth target within two years will be difficult, but that is less important than creating public and market expectations that deflation has been conquered and that appropriately small increases in the CPI will be sustained. This will be a major monetary policy achievement. Whether Abe’s other arrows can reach their targets, however, is a different question altogether.
Hugh Patrick is Director of the Center on Japanese Economy and Business and the Robert D. Calkins Professor Emeritus of International Business at Columbia University.
This article is the first of three articles by the author on whether Abenomics can succeed.