Former Japanese Prime Minister Shinzo Abe died today. May his soul rest in peace! He transformed Japan’s economy through some measures now known as Abenomics. I wrote an article on Abenomics two years ago when he stepped down as the nation’s Prime Minister. Hope this gives a comprehensive picture of his policies and Japan’s economy prior to the pandemic.

Note that the data are retrieved in November 2020 and have not been updated. The original article was published in IIM’s Bottomline magazine in the December 2020 issue.

JAPAN – CRAVING FOR INFLATION

Japan is infamous for its greying population, persistent deflation, prolonged recession and high public debt. Shortage of working-age population has directly affected consumption and general price levels. Persistent lower prices have affected public psyche: they perceive deflation as normal and expect it to continue. This has impacted incomes as employees don’t demand pay hikes, which in turn, affects prices of goods and services. Businesses have little incentive to invest in such economy leading to reduction in natural rate of interest, which then spirals into a vicious circle of economic problems.

In the late 2012, Mr Abe Shinzo assumed the office of Prime Minister and in great zeal aimed at “three arrows” in order to revive dwindling economy. They were: aggressive monetary easing, expansive fiscal policy and structural reforms, called as ‘Abenomics’. The Bank of Japan (BOJ), under the leadership of Mr Kuroda (March 2013 onwards), coordinated with the government to achieve these goals.

Abe-Kuroda Partnership

Theoretically, large government spending and low interest rates influence inflation and can help in restarting economic engine. But Japan already has low interest rates (Fig 2) and high fiscal deficit and debt (Fig 4) leaving no room for further expansion. Abe controlled additional borrowings (Fig 4 – Public debt remained constant after 2013) and implemented structural reforms which narrowed the output gap (Fig 1), improved employment conditions (Fig 3), increased labour productivity and enabled corporate governance. These steps pushed corporate profits and stock markets upwards.

In order to increase the prices of goods as well as tax revenue, Abe increased consumption (sales) tax from 5% to 8% in April 2014 and to 10% in October 2019. But, both times, it invited recession. Consumption tax is highly sensitive and an unpopular issue within public. These controversies date back to 1989 when it was first introduced at 3% rate. Whenever tax rate has been increased, it was followed by large public outcry and recession, threatening incumbent PMs popularity. Yoshihiko Noda administration (prior to Abe’s), however, facilitated tax system reform in consensus with opposition parties and accordingly planned tax hikes from 5% to 8% in April 2014 and to 10% in October 2015. Abe postponed tax hike to 10% twice before implementing it finally in 2019 in order to avoid unfavourable political and economic consequences.

He made changes in labour conditions and laws by initiating parental leave, child care services, allowing companies to employ part-time/contractual workers, equal-work-equal-pay rights, relaxation in immigration policies, etc.

We need to understand three distinct aspects of Japan to understand the success and failure of Abenomics. Firstly, Japan has a lifetime employment system, where a graduate is hired directly from school, who then undergoes on-the-job training, get seniority-based promotions and long-term care benefits under the assumption that he/she will stay until retirement. Such monogamous relationship with the firm does not stimulate efficiency and competitive pressures. Lower salary expectations disincentivise companies to pass increased profits to employees. In addition to it, employing contractual labour proved cost-efficient to companies thereby reducing unemployment problem too. Secondly, Japanese corporate culture is sexist in different ways. Women are not treated at par with men, in terms of roles and pay. Women are forced to quit once they get pregnant and are discouraged to rejoin. During Abe’s tenure, due to several women-friendly laws, female labour-force participation grew from 63% to 71%, higher than in America. But we still read reports of unfavourable working atmosphere and pay gap between men and women. Thirdly, Japanese population is homogenous due to its longstanding opposition to immigration and strict policies. However, in order to fix labour shortages, the government officially opened doors to lower-skilled foreign workers in April 2019. During Abe’s tenure, the number of foreign workers in Japan more than doubled.

This year, Mr Abe announced his resignation a year before his tenure, amid pandemic. His approval rating was mere 33% just before his resignation. Consumption tax hikes and mismanaged pandemic contributed to his falling popularity.

Mr Kuroda, on the other hand, wanted to regain public confidence towards central bank. Prior to Kuroda, the biggest failure of the central bank was linking deflation with declining real potential growth and passing the onus of it’s healing on the fiscal authorities. Such stance decreased public’s confidence on BOJ which amplified the issue and made deflation-fighting exercise worthless. Kuroda focussed on effective communication and aggressive monetary easing through innovative measures elaborated in the next section.

Monetary Policy Evolution in Japan

Post-GFC, we have seen central bankers using ‘unconventional monetary policy tools’, quantitative easing (QE) being the major one. These tools became quintessential to those central banks whose policy rates are near zero and therefore cannot increase money supply by cutting interest rates further. However, BOJ was the first to test the uncharted waters of zero interest rates and QE.

In 2001, when the economy started decelerating post bursting of Dot-com bubble, BOJ adopted quantitative easing (QE) along with zero interest rate policy. It shifted the operating target from short-term interest rate (call-rate) to current account balances of financial institutions maintained with itself. It committed to this policy until inflation (core CPI) is stable at 0% or more (also known as forward guidance). These measures increased balance sheet size of BOJ, reduced long-term yields, helped commercial banks in writing off bad loans and stabilised financial markets. BOJ suspended QE and reset the operating target from current account balance to call rate in March 2006.

Post GFC, the bank slashed interest rates and continued with QE with an aim to support corporate financing as well as maintaining financial stability, which included swap agreements with other central banks, and purchase of government bonds, commercial papers and corporate bonds. Hiroshi Nakaso, Deputy Governor of BOJ (2013-18), stated that most central bankers followed these four approaches after GFC: i) shifting the operating target from short-term rates to the longer-term rates; ii) influencing the risk premium through purchases of risky assets, commonly known as qualitative easing in Japan and credit easing in US; iii) removing the zero lower bound approach through introducing negative interest rates. Sweden’s Riksbank was the first to adopt negative interest rates in July 2009; iv) reducing real interest rates by influencing people’s inflation expectations.

Until 2010, BOJ adopted first two approaches through Asset Purchase Program and forward guidance. However, these measures did not stimulate the economy and the prices as expected. In April 2013, it adopted all the four approaches through its qualitative and quantitative easing (QQE) program that included negative interest rates and committing to 2% inflation target and purchases of large-scale government bond and other assets like ETFs. The key change was shifting the operating target from overnight call rate to the monetary base. These measures in consonance with fiscal policy improved the output gap, corporate profits and employment conditions, and also pushed the wages and prices upwards.

However, the economy faced deflation again around 2016 due to multiple factors like collapse of commodity prices, economic recession in Japan and slowdown in emerging economies. This time, BOJ modified QQE by introducing ‘QQE with Yield Curve Control (YCC)’ in September 2016. It included two components: i) setting short-term interest rate at -0.1% and targeting long-term interest rate at 0% through market operations; and ii) inflation-overshooting commitment, where the bank commits itself to expand monetary base until the annual inflation rate is 2% and stays above the target in a stable manner. Due to this policy, short term as well as long term yields fell without having to purchase large quantities of government bonds like during QQE 2013 program.

Japan finally came out of deflation through 2018 and 2019 but could not reach annual inflation target of 2%. In 2020, the country was struck with Covid-19 pandemic which dismantled most economic levers, pushing Japan into yet another deeper recessionary and deflationary phase. Currently, the bank remains focussed on increasing money supply through supporting corporate finance, active purchases of ETFs and REITs, and accumulating enough local and foreign currency funds.

Conclusion

Although Japanese economy was struggling to reach its target, all glimmers of hope have now been shattered by Covid-19. Although Abe’s successor, Mr Yoshihide Suga would probably continue Abenomics, fiscal policy will remain under pressure owing to demand for higher fiscal stimulus, economic recession, increased unemployment, increased social security spending, low revenue generation avenues and high public debt. BOJ, on the other hand, needs to restart its mission of building inflationary expectations and might have to innovate another weapon in its policy armour.
Japan’s fight for inflation would probably continue for more time now but it remains a guiding star for many countries. Greying population is a common trend in Europe and US, but its openness towards immigration, relatively higher fertility rates and higher investments have saved them from Japan-like situation for now. But in the post-Covid world, managing economies will be an arduous task.

We have seen above how various factors like demography, culture, and behaviours shape public reactions and expectations which directly or indirectly impacts policy outcomes. As economics and policy enthusiasts one cannot overlook these factors and therefore, it is imperative to understand their role and function in each policy matter in any country of study.

– Swapnil Karkare