David Pilling: The verdict on Abenomics is ‘so far, so good’

Last year The Economist magazine devoted two colourful illustrations to the phenomenon of Abenomics, the radical policy to reflate Japan’s economy named after Shinzo Abe. One, bearing the title “Is it a bird? Is it a plane? No . . . It’s Japan!” showed the Japanese prime minister soaring Superman-like through the air. A second, published after stock market jitters last summer, portrayed him plummeting haplessly to the ground. Fifteen months after he came to power, it is time for an Abe audit.

In truth, we are no closer to knowing whether the attempt to banish deflation will end in tears. Those who say it will argue that, because of Japan’s huge stock of debt, if interest rates spike as a result of higher inflationary expectations, the government will be forced to default. In other words, it is precisely when Abenomicsreaches its stated aim that it will begin to unravel.

One senior banker argues that Japan’s debt situation means that it was always going to “hit a wall”. Abenomics, in his opinion, merely hastens that day.

For those who regard this view as unnecessarily alarmist, the question must be: how close is Japan to achieving its 2 per cent inflation target? This question was posed last week at a Brookings Institution conference by two economists, Joshua Hausman of the University of Michigan and Johannes Wieland of the University of California, San Diego. In a paper – “Abenomics: Preliminary Analysis and Outlook” – they conclude stridently that the policy both “ended deflation in 2013 and raised long-run inflation expectations”. They also say it lifted 2013 output growth by between 0.9 and 1.7 percentage points.

That sounds like a pretty good report card. Less positively, the economists judge the central bank’s 2 per cent inflation target as “not yet fully credible”. They also argue that the size of the policy’s stimulatory effect is likely to fall short of what they deem to be Japan’s large output gap – the difference between real and potential output.

If they are right, Abenomics is more likely to end in Abefizzle than Abegeddon. Much of the argument hinges on the size of the output gap.

As Jonathan Allum, a strategist at SMBC Nikko Capital Markets, points out in an excellent note, the International Monetary Fund puts this at a relatively narrow 0.9 per cent, with the OECD club of mostly rich nations judging there to be no output gap at all. Not so, say Drs Hausman and Wieland. They argue that the Lehman crisis has had less of an impact on potential growth than generally thought. They put Japan’s output gap at anywhere between 4.5 per cent and 10 per cent.

The debate seems esoteric. It is not. If Japan is already at its growth potential as the OECD contends, then the only way of raising real growth will be through implementing structural reforms. This is Mr Abe’s third arrow. That arrow has so far disappointed. To many it looks more like a poisoned dart. However, if Drs Hausman and Wieland are right, the third arrow may not be so important. Monetary policy could achieve much on its own by closing the gap. That would imply the Bank of Japan will need to do more since inflation normally only takes hold when there is more demand than supply, not the other way around.

On the surface the battle against deflation is going well. The headline inflation rate is running at 1.4 per cent, a tad higher than Germany, at 1.2 per cent. However, much of this is imported through higher energy costs. Strip out those and inflation is rising at only 0.7 per cent. The danger is it will simply peter out.

Two things could be decisive. The first is wages. If consumer confidence is not to be knocked for six, pay will have to start rising. Many big companies have been arm-twisted into lifting wages by between 1 per cent and 2 per cent. Nor is the news for smaller companies, which employ 70 per cent of workers, all bad. This month small company confidence rose to its highest level since 1989. Advertised jobs are up by more than 30 per cent since last year. Some industries, such as construction and trucking, cannot find workers for love nor money. Demographics, normally perceived as a looming catastrophe, may actually help in the short run by tightening the labour market further.

The second factor is the consumption tax, which from next month will rise from 5 per cent to 8 per cent. That may seem modest. It may also seem necessary to begin to repair Japan’s fiscal hole. If, however, you were designing a policy to reflate the economy, taking away consumers’ spending power would not seem like the best way to go about it.

It may take another few quarters to assess both the impact of the tax rise and the durability of the inflation numbers. Mr Allum says the policy has gone better than expected. “At some point, perhaps, the commentariat may have to rethink its scepticism,” he says.

The verdict on Abenomics must be “so far so good”. Sceptics, though, will continue to wonder how Abenomics can defy what they regard as the forces of gravity.


David Pilling


Fonte: FT