Yesterday's swearing in of Liberal Democratic Party Prime Minister Shinzo Abe is set to deliver a policy reform agenda that is designed to drag Japan out of two decades of economic weakness, including 15 years of deflation and plummeting asset prices.
In simple terms, Abe wants to inflate the Japanese economy by coordinating easy money and a dose of fiscal stimulus. One feature of Abe’s economic agenda is to overhaul the Bank of Japan with a "bold monetary easing” which will have as its focus a 2 per cent inflation target. Informally it will aim for nominal GDP growth of 3 per cent. In recent decades, these economic results have rarely been seen.
Abe’s proposal is for "unlimited cash provisions to spur inflation and growth”. It seems to be a variant of the policy approach being adopted by the US Federal Reserve, the European Central Bank and the Bank of England to do whatever it takes to kick-start economic growth in their economies. It's something that has been lacking in Japan since the late 1980s bubble burst.
Abe also wants to use fiscal policy to stimulate economic activity, despite chronic budget deficits and gross government debt levels around 230 per cent of GDP. The current expectations are that a fiscal stimulus package, to be announced in late January, will include extra spending of around ¥10 trillion ($A110 billion) with the focus on public works and infrastructure. A ¥10 trillion package is approximately 1.5 per cent of GDP so it should have a notable impact on economic activity.
In terms of the task confronting Abe and his plan to inflate the Japanese economy, it is noteworthy that the last time Japan recorded annual inflation of 2 per cent was 1997, and this result was heavily influenced by a rise in sales tax which provided a one-off boost to prices. Before that, it was in 1992 that inflation was above 2 per cent for more than two straight years.
Despite almost two decades of deflationary economic funk, Japan remains the fourth largest economy in the world (GDP, purchasing power parity basis), having been overtaken this year by India. Japan accounts for around 5 per cent of global GDP, meaning it can make a strong contribution to global economic activity if a decent rate of growth can be regained and sustained.
Abe’s policy agenda will not yield overnight benefits. It will take some time to get the policies implemented and then functioning to underpin growth. The benefits of the policy changes are unlikely to be seen until the second half of 2013 at the earliest, although the markets are increasingly looking at the policy reform agenda with a high degree of enthusiasm.
The Japanese yen has fallen 10 per cent in recent weeks to be at a 20-month low of 85 against the US dollar. This is providing a significant competitive boost to Japanese exporters and a further yen decline is likely as the BoJ prints money to move inflation higher, towards its new target.
At the same time, the Nikkei 225 stock market has risen for seven straight weeks – for a cumulative 20 per cent rise in just over two months – as an LDP victory was increasingly assured. Having been absolutely smashed as the asset bubble burst, the Nikkei nonetheless remains around 70 per cent below the level of the late 1980s, which perhaps best highlights the extent of the problems Abe is trying to address.
A strong Japan would be a further shot in the arm for the Australian economy. Japan remains Australia’s second-largest export market, taking over 19 cent of merchandise exports (with the two major items coal and iron ore). If Japan were to climb out of its deflationary funk, demand for Australian commodities would inevitably rise.
If at the same time China and India can keep their growth momentum going, the next couple of years will be good ones for Australian exporters and the economy more generally.