Rationale and impact of Japan’s expansionary fiscal policy and monetary easing
Japan’s economy has for over two decades been gripped by a condition described as suspended animation. The economy was beset by a depression following the asset bubble burst in the early 1990s, leading it to suffer recession (The Economist, 2013). Worsening the depression was the 1997 hike on consumption-tax. GDP growth consequently rate plunged to an all-time low of -1.8 percent in 1998 and the unemployment rate soared over 4 percent with the slowed growth hindering the absorption of the unemployment (Anatoe, 2013). Japan’s economy was further weighed down by deflation which had devastating consequences on the economy making it difficult for successive regimes to restart the economic engine and, therefore, to get back on the growth path. Deflation significantly impacts the economy increasing the real (inflation-adjusted) debt burden as well as the real interest rate (Evan, 2013).
However, even after such sustained stagnation, Japan remains the third-largest economy in the world with a 2012 GDP of $6 trillion (IMF, 2012). It has, in recent years, shown signs of economic recovery with GDP growing at an annualized rate of 3.5 percent with the realization of 0.9 percent growth in the three months to March compared to the previous quarter. At the end of 2012, the Japanese economy, emerging from the recession grew at a rate of 1 percent (Evan, 2013; Anatoe, 2013). This growth and recovery is attributed to an attempt to stimulate the economy through aggressive monetary easing by the country’s central bank, the Bank of Japan, as well as big government spending. These decisive steps are contained in a new economic policy fronted by Japan’s Prime Minister, Shinzo Abe, popularly referred to as ‘Abenomics’ (Anatoe, 2013).
This paper explores the rationale of Japan’s expansionary fiscal policy and monetary easing, discussing their impact on both the domestic and global economy over the short and longer term with regard to relevant theory.
In an endeavour to resolve macroeconomic problems facing the country, Japan, in a complete break from the past, is pursuing the recently introduced policy package consisting of a three-pronged approach including: a flexible fiscal policy, a bold monetary policy and a growth strategy focused on encouraging private sector investment. The country is actively pursuing both an expansionary fiscal policy and monetary easing to revitalize the economy, ridding it of the deflation that it has suffered for two decades (Anatoe, 2013). Deflation in the economy is evidence of persistently inadequate demand (Case and Fair, 2006), with Japan’s national income (in nominal terms), despite perceived growth in the economy, still actually less than it was in 1994 (Evan, 2013).
In the view of many economists regarding Japan’s economic challenges, macroeconomic stimulus concentrated on boosting demand, as pursued in the ‘Abenomics’ policy package, was long overdue (David, 2013; Anatoe, 2013; Evan, 2013). Post world war two, Japan rebuilt itself industrially and in sustaining a weak Yen and maintaining low labour costs, was able to flood Western markets with its exports. It, thus, was able to channel money back into society thereby realizing consistent economic assent. However, in the 1980s, shifts in dollar value and subsequent interventions led to the strengthening of the Yen. In an attempt to counter this unfavourable strengthening, the Bank of Japan (BOJ) issued vast quantities of Yen, massively increasing the money base (Anatoe, 2013). This ‘easy money’ coupled with very low interest rates drove real estate and stock prices upwards to unreasonable levels, exacerbated by money inflows from the US and Europe. The country entered an economic bubble which subsequently burst wiping out tens of trillions of dollars in wealth and massive tumbles in asset prices (Evan, 2013; The Economist, 2013).
To counter the tumble, BOJ increased spending and tried to encourage more lending, arranged bailouts of banks and insolvent firms leading to a cycle of stagnation, and continuously lowered interest rates, to its lowest 0.1%. Pensions and life-savings were wiped out and people became risk averse (Evan, 2013). A negative birth rate and the resulting shift in demographics is a significant structural problem that has led to the shrinking of the productive segment of the population and production capacity with dire economic and social implications contributing to the two decade stagnation (David, 2013; Anatoe, 2013). The country is at a tipping point and in the two decades has been living off past savings and sustaining its lifestyle, maintaining the facade of equilibrium through deficit spending, backed by internal borrowing. Despite extreme growth in debt, this has insulated it against the kind of crises seen in Europe (Evan, 2013).
This dire scenario necessitates the bold and drastic stimulus measures such as contained in the ‘Abenomics’ policy package (Anatoe, 2013; The Economist, 2013). Such measures are in line with the circular flow of income economic model which describes the reciprocal cycle of incomes between producers on the one hand and consumers on the other. With the unlimited and recurring nature of human wants driving demand and continuous production, these entities provide each other with factors that facilitate the circular flow of income. Firms provide consumers with goods and services in exchange for their monetary expenditure, with another level of their engagement involving exchange of factors of production such as land, labour and capital for rent, wages, interest and profits. This latter income for the household sector drives expenditure and consumption from the business sector completing the continuous cycle (Hansen, 2003; O’ Sullivan and Steven, 2003). The more realistic five-sector model of the circular flow of income entails producers and consumers, in addition to financial, government, overseas sectors engaged and influencing the cycle.
A state of equilibrium in the circular flow of income occurs when the total leakages from the economy (savings, taxes and imports decreasing money supply) equal total injections (investment, government expenditure and exports increasing money supply). States of disequilibrium affect income, production (output), expenditure and employment with their levels falling leading to recession or contraction of economic activity if leakage surpasses injections or rise leading to boom and expansion if injections exceed levels of leakage (Case and Fair, 2006).
Reduction of income leads households to cut down on savings and expenditures in taxation and importation leading to a fall in leakage. This is driven until leakages equal the lower injections into the economy thereby lowering the level of equilibrium and vice versa. This model outlines the interdependence of the various factors interplaying in the economy, balancing production and consumption through controls such as incomes and, therefore, demand and expenditure (Vladimir, 2011). Fiscal and monetary policy strategies seek to bring the economy to a level of equilibrium, or when necessary, to encourage disequilibrium which gives a semblance of growth, increasing injections into the economy and thereby fostering boom and expansion in the economy. It also serves to temper growth when the economy heats up (O’ Sullivan and Steven, 2003). To restart Japan’s battered economy and to drive it into a growth path, there was need for such drastic measures increasing the requisite injections and thereby safeguarding the economy from the unfavourable recession and a contraction of the overall economy (Heyne, Boettke, and Prychitko, 2002).
The stimulus package entailed a 10.3 trillion Yen stimulus, the takeover of Japan’s Central Bank which hitherto was unwilling to undertake the required bold experiments in monetary policy, and commitment to clear-cut comprehensive structural reform (The Economist, 2013). These initiatives were founded upon Keynesian economic theories based on the belief that proactive actions of government comprise the only means to steer the economy. Government should employ its power to increase spending and create an easy money environment thereby increasing aggregate demand (Galor, 2005).
These stimulus measures have received a good report from various analysts with most perceiving Japan’s economy to be on the right track to recovery. This is evidenced by citations of a jump in individual spending on the back of a rally in Japanese stocks, as well as recovering exports. Of note is the rise of the main Nikkei 225 45% this year with the 3.5% anticipated growth rate expected to outpace major economies such as the US and the Eurozone (The Economist, 2013). Falling prices deter spending both by business and consumers (injections) with their tendency to hold out for a better deal with a consequence of reduced demand overall. Pumping trillions of Yen into the money supply (leakage) has therefore been beneficial in pushing down the currency’s value and has significantly helped exporters enhancing their competitiveness in overseas markets and increasing the value of the profits repatriated (Anatoe, 2013). This has also led to the huge rally in Japanese stocks as investors rush to take advantage of the potential for companies to acquire bigger earnings (Evan, 2013).
Despite the plan’s short-term success, some analysts are however questioning the sustainability of the recovery. Hesitation by companies to boost their investment in spite of improved business sentiment is cited pointing at company spending which fell 0.7% in the three months although an increase was expected (Evan, 2013). Convincing companies to spend is a key part of the stimulus plan enabling the pulling of the country out of deflation. Also crucial is the interplay between Japan and other countries its neighbours, relates to and competes against, notably China, Taiwan and South Korea. The monetary and fiscal stimulus designed to end chronic deflation has seen a sharp devaluation of the Yen which is not only unsustainable, but also unfair to other countries. This type of recovery is unfair since it comes at the expense of Japan’s trading partners and geopolitics, with strong economic policy reactions from Japan’s neighbours almost inevitable (David, 2013). There is a risk of their interference in the foreign exchange markets to stop the appreciation of their currencies with trade disputes likely to emerge against certain Japanese exports and increasing scrutiny of Japanese investments (David, 2013). Such moves will prove unfavourable to Japan’s external trade in the longer term.
The challenge going into the future is in seeking to deliver anticipated economic growth following the unprecedented macroeconomic expansion. What is needed is sustainable growth in the longer term and this requires the restructuring of the economy, enhancing overall productivity and increasing the participation of the labour force in production (Vladimir, 2011). Economists and investment analysts looking from the bottom-up are more sceptical citing profound structural problems such as Japan’s shrinking population, misallocation of investment, huge public debt, inflexible labour practices, unimaginative management, protectionist lobbies among others, which can hardly be fixed through monetary policy measures (Evan, 2013). Macro-investors, on the other hand, are contented with the positive fiscal and monetary expansion and consider it a good opportunity to buy Japanese equities and to sell the Yen. If this latter group maintain their bullish run, with enough conviction to trounce the scepticism of the bottom-up investors, Japan’s economy in its present reality could change in the longer term (The Economist, 2013).
Despite initial success in shoring up the stock market and increasing expenditure in the short term, the transmission mechanisms linking the monetary policy to long term economic outcomes for Japan’s economy remain fragile. To ensure a sustainable long-term increase in productive capacity, there is need for plans to fix the deep structural and demographic problems the country faces (The Economist, 2013). Most of these factors are however beyond government control and it can therefore just set the tone, encouraging players in the economy to support the policy measures. An example of this is corporate labour practices under the control of the private sector/business (Vladimir, 2011).
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