After 20 years of hesitation Japan has stepped on to the economic tightrope. To do so is bold and necessary. It is also risky, and the Bank of Japan has taken a wobbly first stride.
Last week, under its new governor Haruhiko Kuroda, the BOJ launched a huge new program of quantitative easing. It is the first real move in Abenomics, the economic program of Shinzo Abe, the new prime minister.
Abenomics aims to solve the world’s toughest economic problem. In fact, Japan has three economic problems, all locked together, forming an equilibrium that makes it impossible to treat any of them in isolation. They are deflation, slow growth and a structural dependence on deficit spending.
Abe is exciting because he has the right diagnosis and the right cure. The plan is monetary stimulus to tackle deflation; fiscal stimulus, followed by consolidation, to create a path back to private demand; and structural reforms to boost growth. Do them all at once, aggressively, for as long as it takes, and it may be possible to snap the economy out of its stasis.
Executed 15 years ago, 10 years ago or even five years ago there would have been every chance of success. Yet as the years passed, the path that Japan must walk has narrowed, with continued deflation on one side or debt crisis on the other. That is no reason not to try. Disaster is otherwise inevitable, which is why the BOJ’s past reluctance to act was so infuriating. But there is no margin for error.
One reason is the depth of deflationary expectations: every past attempt to escape the trap of falling prices has proven to consumers how well they are caught. Remember 2005. The yen was lower at ¥118, compared with ¥97 today; the Nikkei index rose 40 per cent to 16,194, compared with 12,833 today; the rest of the world was booming; and Junichiro Koizumi won re-election on a platform of structural reform. The economy still never got to sustainable inflation (in part, admittedly, because the BOJ raised interest rates).
Japan’s trend growth rate has fallen as the population ages. The years of struggle also raised Japan’s net public debt to 135 per cent of gross domestic product. Everything the BOJ does now must be compatible with a credible fiscal policy.
With these concerns in mind, the BOJ’s first step was not ideal. Kuroda launched an enormous, conventional round of QE in the government bond market. He plans to buy more equity and real estate. And he pledged to keep going until inflation gets to 2 per cent.
The scale of the measures is a good start, but expectations are unlikely to shift without visible results, and even giant QE may still get trapped in the banking system. Buying government bonds leaves the BOJ exposed if the government keeps running deficits. In itself, QE does nothing to promote structural reform, and former governor Masaaki Shirakawa, for all his caution, was rightly keen to do so.
The next step should be much larger BOJ purchases of real assets – in particular, equities. The place to get these shares is from the cross-holdings that corporations and banks hold in each other. Abe and Kuroda should tell Japanese companies that it is their duty to sell to the BOJ.
Unwinding cross-shareholdings would boost competition: it is easier to switch suppliers when they do not own 5 per cent of your stock. It would make banks less exposed to the stock market. BOJ cash would go directly to companies, and if they were pushed to pay dividends, to their shareholders. Finally, it would create a useful tension with Abe by linking the BOJ’s willingness to buy government bonds with progress on fiscal policy.
Abe also needs to deliver while a rising stock market and a falling yen create the space to act. That does not mean needless political pain that destroys his ability to govern – always fragile for a Japanese prime minister – but rather focused moves to show that he will spend the political capital from economic success to buy the next round of economic success.
He should push ahead with planned rises in consumption tax, from 5 per cent to 10 per cent over the next couple of years, even if he offsets the fiscal tightening with other measures in the short term. He should sign up to the trans-Pacific Partnership for trade and defy his party’s conservatives with steps to help Japanese women combine children and a fulfilling career. Bullying the BOJ was the easy part of Abenomics; let us see him do something hard.
Any other country with Japan’s economic statistics would probably be in crisis already. But Japan’s remarkable strengths – its world-class exporters, huge pool of savings and the social cohesion that means difficult reforms are always possible – leave it a way out.
This is probably the last chance that Japan will get to resolve its economic problems without a crash. The tightrope walk has begun. The crowd is holding its breath. Each step must be true.
Copyright The Financial Times Limited 2013