Since coming to office in December 2012, Shinzo Abe’s government has been determined to revive the Japanese economy. For the past 20 years, Japan’s growth has averaged only 0.8% per annum. This compares with 1.3% for Germany, 2.3% for the UK, 2.6% for the USA, 4.9% for South Korea and 10.4% for China.
Japanese real GDP per capita was only 14.5% higher in 2012 than 20 years earlier. This compares with figures for Germany, the UK, the USA, South Korea and China of 27%, 45%, 34%, 126% and 497% respectively.
So what has the Japanese government done to boost both short-term and long-term growth after years of stagnation? There are ‘three arrows’ to the policy, targeted at reviving and sustaining economic growth.
The first arrow is monetary policy. The Bank of Japan has engaged in extensive quantitative easing through bond purchases in order to drive down the exchange rate (see A J-curve for Japan?), stimulate expenditure and increase the rate of inflation. A target inflation rate of 2% has been set by the Bank of Japan. Part of the problem for the Japanese economy over the years has been stagnant or falling prices. Japanese consumers have got used to waiting to spend in the hope of being able to buy at lower prices. Similarly, Japanese businesses have often delayed stock purchase. By committing to bond purchases of whatever amount is necessary to achieve the 2% inflation target, the central bank hopes to break this cycle and encourage people to buy now rather than later.
The second arrow is fiscal policy. Despite having the highest debt to GDP ratio in the developed world, Japan is embarking on a large-scale programme of infrastructure investment and other public works. The package is worth over $100bn. The expansionary fiscal policy is accompanied by a longer-term plan for fiscal consolidation as economic growth picks up. In the short term, Japan should have no difficulty in financing the higher deficit, given that most of the borrowing is internal and denominated in yen.
The third arrow is supply-side policy. On 5 June, Shinzo Abe unveiled a series of goals his government would like to achieve in order to boost capacity and productivity. These include increasing private-sector investment (both domestic and inward), infrastructure expenditure (both private and public), increasing farmland, encouraging more women to work by improving day-care facilities for children, and deregulation of both goods, capital and labour markets. The prime minister, however, did not give details of the measures that would be introduced to achieve these objectives. More details will be announced in mid-June.
The following videos and articles look at the three arrows of Abenomics and the effects they are having on confidence and attitudes as well as on expenditure, output and the exchange rate. They also look at the crucial third arrow: at whether supply-side reforms will be enough to achieve a sustained increase in economic growth.
Videos
Abenomics an uncertain future for most Financial Times on YouTube, Ben McLannahan (30/5/13)
Assessing Abenomics NHK World (3/6/13)
Adam Posen on Abenomics NHK World (30/5/13)
Japanese concerned over ‘Abenomics’ AlJazeera on YouTube (30/5/13)
Abenomics – the cure for deflation? BBC News, Rupert Wingfield-Hayes (10/5/13)
Japan PM’s economic speech ‘short on detail’ BBC News, Rupert Wingfield Hayes (5/6/13)
Pretty Positive on Abenomics Bloomberg, Jan Hatzius, Goldman Sachs (5/6/13)
Why Abenomics is Bonkers: Pro CNBC, Graeme Maxton, (27/5/13)
‘Abe’nomics Not About BOJ Printing Money Bloomberg, Derek Halpenny (31/5/13)
Abenomics Aims `Third Arrow’ at Business Rules Bloomberg, Willie Pesek (5/6/13)
Analysis on Abe’s Growth Plan NHK World (5/6/13)
Articles
Will three arrows find their target? On Line Opinion, Andrew Leigh (6/6/13)
Japan Fires ‘Third Arrow,’ but Will It Work? CNBC, Dhara Ranasinghe (5/6/13)
Japan’s ‘3 Arrows’ May Run Into German Wall CNBC, Michael Ivanovitch (19/5/13)
Japan’s recovery – the power of Abe’s three arrows Commonwealth Bank, Australia, Melanie Timbrell (31/5/13)
So Far, the Battery Charger Is Working in Japan The New York Times, Jeff Sommer (18/5/13)
Abenomics Could Light A Fire Under The Japan Trade Again Business Insider, Matthew Boesler (4/6/13)
Japan’s New Prime Minister Unveils The ‘Most Important’ Plank Of Abenomics Business Insider (5/6/13)
Japan PM pledges to boost incomes by 30% Channel NewsAsia (5/6/13)
Abe’s growth strategy disappoints economists, investors The Asahi Shimbun (6/6/13)
Abenomics Won’t Be ’Magic Bullet’ for Japan, Says Johnson of MIT Bloomberg, Cordell Eddings (5/6/13)
Too soon to call time on Abenomics BBC News, Stephanie Flanders (19/6/13)
Abenomics: The objectives and the risks BBC News, Puneet Pal Singh (19/7/13)
Data
World Economic Outlook Database IMF
Bank of Japan Statistics Bank of Japan
Economic Outlook Annex Tables OECD
Country statistical profile: Japan 2013 OECD
Questions
- Demonstrate on (a) an aggregate demand and supply diagram and (b) a Keynesian 45° line diagram the effects of the three arrows (assuming they are successful) in meeting their objectives.
- What will determine the effectiveness of the first two arrows in boosting short-term economic growth?
- Would you characterise the policies of the third arrow as interventionist or market-orientated, or as a mixture? Explain.
- What are the dangers in ‘Abenomics’?
- Find out what has been happening to Japanese bond rates. What are the implications of this for monetary policy?
- What are the ‘markets telling Abe’?
- In what ways will expectations influence the effectiveness of Abenomics?
After a week of turmoil in Cyprus (see the News item Ochi, ochi, ochi) a deal has been struck between Cyprus, the EU and the IMF over a €10bn bailout for the island’s banking system. But while the deal may bring the immediate crisis to an end, the Cypriot economy could face years of austerity and depression. And there remain questions over whether the deal sends the wrong message to depositors in banks in other eurozone countries whose banking systems are under pressure.
Unlike the original EU proposal, the deal will not impose a levy on deposits under €100,000, much to the relief of small and medium depositors. But individuals and businesses with deposits over €100,000 in the two main troubled banks (Laiki and the Bank of Cyprus) will face losses that could be as high as 40%. The precise size will become clear in the coming days.
The troubled second largest bank, Laiki (Popular) Bank, will be split into a ‘good’ and a ‘bad’ bank. The assets and liabilities of the good part will be taken over by the largest bank, the Bank of Cyprus. Thus people’s accounts under €100,000 will be moved from one to the other. The ‘bad’ part will include deposits over €100,000 and bonds. Holders of these could lose a substantial proportion of their value.
Many businesses will be hard hit and may be forced to close. This could have serious adverse multiplier effects on the economy. These effects will be aggravated by the fiscal austerity measures which are also part of the deal. The measures are also likely to discourage further inward investment, again pushing the economy further into recession.
And then there are the broader effects on the eurozone. The direct effect of a decline in the Cypriot economy would be tiny; the Cypriot economy accounts for a mere 0.2% of eurozone GDP. Also the effect on small savers in other eurozone countries is also likely to be limited, as people will probably be reassured that savings under €100,000 have remained protected, even in an economy as troubled as Cyprus.
But some commentators argue that the effect on large depositors in other troubled eurozone countries, such as Portugal, Spain, Greece and Italy, could be much more serious. Would people with large balances in these countries prefer to move their money to, say, Germany, or even out of the eurozone altogether? There is clearly disagreement over this last point as you will see from the articles below.
Webcasts and Podcasts
Cyprus agrees bailout with eurozone ministers The Guardian (25/3/13)
Cyprus bailout: Deal reached in Eurogroup talks BBC News (25/3/13)
‘Disaster avoided’ as Cyprus agrees EU bailout deal Euronews (25/3/13)
Cyprus saved from bankruptcy Channel 4 News on YouTube, Faisal Islam (25/3/13)
What are the implications of the Cyprus deal? BBC Radio 4 Today Programme, Stephanie Flanders (25/3/13)
Cyprus bailout deal: Russia riled but Germany relieved BBC News, Steve Rosenberg in Moscow and Stephen Evans in Berlin (25/3/13)
Cyprus bailout deal ‘durable’ says IMF chief BBC News, Christine Lagarde (25/3/13)
Cyprus Bailout Deal Raises Questions: Lombardi Bloomberg, Domenico Lombardi (25/3/13)
Minister Michalis Sarris: Cyprus paying ‘tremendous cost’ BBC Radio 4 Today Programme, Michalis Sarris (26/3/13)
Articles
Last-minute Cyprus deal to close bank, force losses Reuters, Jan Strupczewski and Annika Breidthardt (25/3/13)
Cyprus strikes last-minute EU bailout deal The Guardian, Ian Traynor (25/3/13)
‘There is no future here in Cyprus’ The Telegraph, Nick Squires (25/3/13)
Back from the brink: EU ministers approve €10bn bailout deal at 11th-hour to save Cyprus Independent, Charlotte McDonald-Gibson and Majid Mohamed (25/3/13)
Cyprus bailout: Deal reached in Eurogroup talks BBC News (25/3/13)
Q&A: Cyprus deal BBC News (25/3/13)
The rescue of Cyprus won’t feel like one to its people BBC News, Robert Peston (25/3/13)
Lessons of Cyprus BBC News, Stephanie Flanders (25/3/13)
Cyprus bailout: Dijsselbloem remarks alarm markets BBC News (25/3/13)
Cyprus saved – but at what cost? The Guardian, Helena Smith (25/3/13)
Cyprus bail-out: savers will be raided to save euro in future crisis, says eurozone chief The Telegraph, Bruno Waterfield (25/3/13)
Cyprus’s banks have been tamed – are Malta and Luxembourg next? The Guardian, Ian Traynor (25/3/13)
Lehman lessons weigh on Cyprus talks but 1920s slump must not be ignored The Guardian, Larry Elliott (24/3/13)
Questions
- Explain what is meant by ‘moral hazard’. What moral hazards are implicit in the deal that has been struck with Cyprus?
- How does the size of the banking system in Cyprus as a proportion of GDP differ from that in other troubled eurozone countries? How does this affect the ‘contagion’ argument?
- Does the experience of Iceland and its troubled banks suggest that the Cypriot problem has nothing to do with its being in the eurozone?
- What options are open to the Cypriot government to stimulate the economy and prevent a severe recession? How realistic are these options (if any)?
- What are the likely implications of the deal for the economic relationships (as opposed to the political ones) between Cyprus and Russia and between the eurozone and Russia?
- Are there any similarities in the relationships between the weak and strong eurozone countries today and those between Germany and other countries in the 1920s and 30s?
The UK economy is suffering from a lack of aggregate demand. Low spending in real terms is preventing the economy from growing. A simple solution would seem to be to stimulate aggregate demand through fiscal policy, backed up by even looser monetary policy. But this is easier said than done and could result in undesirable consequences in the medium term.
If increased borrowing were to be used to fund increased government expenditure and/or cuts in taxes, would any resulting growth be sufficient in the medium term to reduce the public-sector deficit below the initial level through automatic fiscal stabilisers? And would the growth be sustainable? The answer to this second question depends on what happens to the supply side of the economy. Would there be an increase in aggregate supply to match the increase in aggregate demand?
This second question has led many economists to argue that we need to see a rebalancing of the economy. What is needed is an increase in investment and exports, rather than an increase in just consumer expenditure funded by private borrowing and government current expenditure funded by public borrowing.
But how will exports and investment be stimulated? As far as exports are concerned, it was hoped that the depreciation of the pound since 2008 would give UK exporters a competitive advantage. Also domestic producers would gain a competitive advantage in the UK from imports becoming more expensive. But the current account deficit has actually deteriorated. According to the EU’s AMECO database, in 2008 the current account deficit was 1% of GDP; in 2012 it was 3.7%. It would seem that UK producers are not taking sufficient advantage of the pound’s depreciation, whether for exports or import substitutes.
As far as investment is concerned, there are two major problems. The first is the ability to invest. This depends on financing and things such as available land and planning regulations. The second is the confidence to invest. With not little or no growth in consumer demand, there is little opportunity for the accelerator to work. And with forecasts of sluggish growth and austerity measures continuing for some years, there is little confidence in a resurgence in consumer demand in the future. (Click here for a PowerPoint of the above chart. Note that the 2013 plots are based on AMECO forecasts.)
So hope of a rebalancing is faint at the current time. Hence the arguments for an increase in government capital expenditure that we looked at in the last blog post (The political dynamite of calm economic reflection). The problem and the options for government are considered in the following articles.
Articles
Budget 2013: Chancellor’s rebalancing act BBC News, Stephanie Flanders (11/3/13)
Why George Osborne is failing to rebalance the economy The Guardian, Larry Elliott (17/3/13)
Economy fails to ‘rebalance’ Financial Times, Sarah O’Connor (27/2/13)
Analysis – Long haul ahead for Britain’s struggling economy Reuters, William Schomberg (3/3/13)
Can banks be forced to lend more? BBC News, Robert Peston (12/3/13)
Budget 2013: What the commentators are saying BBC News (13/3/13)
Data
UK Trade, January 2013 (ONS) (12/3/13)
Business investment, Q4 2012 ONS (27/2/13)
Questions
- Draw a diagram to illustrate the effects of a successful policy to increase both aggregate demand and aggregate supply. What will determine the effect on the output gap?
- For what reasons has the UK’s current account deteriorated over the past few years while those of the USA and the eurozone have not?
- Using ONS data, find out what has happened to the UK’s balance of trade in (a) goods and (b) services over the past few years and explain your findings.
- Why are firms reluctant to invest at the moment? What policy measures could the government adopt to increase investment?
- With interest rates so low, why don’t consumers borrow and spend more, thereby aiding the recovery?
Moody’s, one of the three main international credit rating agencies, has just downgraded the UK’s credit rating from the top Aaa rating to Aa1. The other two agencies, Standard & Poor’s and Fitch may follow suit as they have the UK’s triple A rating on ‘negative outlook’.
The reason for Moody’s decision can be see in its press statement:
The key interrelated drivers of today’s action are:
1. The continuing weakness in the UK’s medium-term growth outlook, with a period of sluggish growth which Moody’s now expects will extend into the second half of the decade;
2. The challenges that subdued medium-term growth prospects pose to the government’s fiscal consolidation programme, which will now extend well into the next parliament;
3. And, as a consequence of the UK’s high and rising debt burden, a deterioration in the shock-absorption capacity of the government’s balance sheet, which is unlikely to reverse before 2016.
The direct economic consequences of Moody’s action are likely to be minimal. People were excpecting a downgrade sooner or later for the reasons Moody’s quotes. Thus stock markets, bond markets and foreign exchange markets already reflect this. Indeed, in the first seven weeks of 2013, the sterling exchange rate index has depreciated by over 6%.
The political consequences, however, are likely to be significant. The Chancellor of the Exchequer, George Orborne, has put considerable emphasis on the importance of maintaining a triple A rating. He has seen it as a sign of the confidence of investors in the government’s policy of focusing on cutting the public-sector deficit and, ultimately, of cutting the public-sector debt as a proportion of GDP. His response, therefore, has been that the government will redouble its efforts to reduce the deficit.
Not surprisingly the Labour opposition claims the downgrading is evidence that the government’s austerity policies are not working. If the aim is to cut the deficit/GDP ratio, this is difficult if GDP is falling or just ‘flat lining’. A less aggressive austerity policy, it is argued, would allow growth to recover and this rise in the denominator would allow the deficit/GDP ratio to fall.
Latest forecasts are that government borrowing is set to rise. The average of 24 independent forecasts of the UK economy, published by the Treasury on 13/2/13, is that public-sector net borrowing will rise from £90.7bn in 2012/13 to £107bn in 2013/14. And the European Commission forecast of the UK economy is that the general government deficit will rise from 5.9% of GDP in 2012/13 to 7.0% of GDP in 2013/14.
So what will be the economic and political consequences of the loss of the triple A rating? What policy options are open to the government? The following articles explore these questions. Not surprisingly, they don’t all agree!
Downgrading Britain: The Friday night drop The Economist, Buttonwood’s notebook (23/2/13)
Rating downgrade: Q&A The Observer, Josephine Moulds (24/2/13)
Downgrade is Osborne’s punishment for deficit-first policy The Guardian, Phillip Inman (23/2/13)
Britain’s downgraded credit rating: Moody’s wake-up call must trigger a change of course The Observer (24/2/13)
Editorial: AAA loss is a sign of failure Independent (24/2/13)
It’s not the end of the world – but it’s the end of any false complacency Independent, Hamish McRae (24/2/13)
Moody’s downgrade will stiffen George Osborne’s resolve The Telegraph, Kamal Ahmed (23/2/13)
UK AAA downgrade: Budget is now George Osborne’s make or break moment The Telegraph, Philip Aldrick (23/2/13)
Britain’s credit downgrade is a call to live within our means The Telegraph, Liam Halligan (23/2/13)
Britain will take years to earn back AAA rating, says Ken Clarke The Telegraph, Rowena Mason (24/2/13)
Questions
- How important are credit agencies’ sovereign credit ratings to a country (a) economically; (b) politically? Why may the political effects have subsequent economic effects?
- Explain the meaning of the terms ‘exogenous’ and ‘endogenous’ variables. In terms of the determination of economic growth, are government expenditure and tax revenue exogenous or endogenous variables? What are the implications for a policy of cutting the government deficit?
- Identify the reasons for the predicted rise in the public-sector deficit as a proportion of GDP. Which of these, if any, are ‘of the government’s own making’?
- In the absence of a change in its fiscal stance, what policies could the government adopt to increase business confidence?
Each month the accountancy firm BDO publishes its Business Trends Indices. These indices “are ‘polls of polls’ that pull together the results of all the main UK business surveys”. The latest report shows that the January 2013 Optimism Index was its lowest since the report began 21 years ago.
The Optimism Index predicts business performance two quarters ahead. In January 2013 it was 88.9. The way the index is constructed, a reading of 95 or more suggests that firms are optimistic about business performance. Clearly, they were pessimistic.
Although there was an increase in hiring intentions, firms were still predicting a fall in output. The indices for optimism, employment and output are shown in the chart. (Click here for a PowerPoint.)
As Peter Hemington, Partner, BDO LLP, commented:
In spite of a strengthening Labour Market, business confidence continues to weaken, and improved hiring intentions are not translating into growth plans. It seems the damaging effects on businesses of five years’ zigzagging economic growth, has left them wary of making concrete plans for expansion and resigned to the ‘new normal’ of economic stagnation.
To end this cycle, it is imperative that the Government implements plans to expedite growth. Without growth incentives, we will continue to see UK businesses reluctant to invest and expand, which poses a grave threat to the UK’s economic recovery.
The following articles comment on the gloomy mood of business and on its implications for output and investment. They also look at the implications for government policy.
Articles
Confidence slumps despite optimism from manufacturers Insider News (11/2/13)
Fears of a triple-dip recession return as survey puts business confidence at a 21-year low This is Money (11/2/13)
Pressure grows on ministers for growth strategy Yorkshire Post (11/2/13)
Triple-dip jitters as business confidence hits 21-yr low Management Today, Michael Northcott (11/2/13)
Report and data
Business Trends: Business confidence hits 21-year low signalling economic contraction BDO Press Release (11/2/13)
BDO Monthly Business Trends Indices, February 2013 – Full Report BDO (11/2/13)
Business and Consumer Surveys European Commission: Economic and Financial Affairs
Questions
- What reasons are given by the report for a decline in business optimism?
- Explain how an accelerator/multiplier interaction could compound the recession or help to cause a bounce back from recession.
- How does business sentiment in one country affect business sentiment in others?
- In the absence of a change in its fiscal stance, what policies could the government adopt to increase business confidence?
- Why might firms’ hiring intentions increase even though they are predicting a fall in output?
Since coming to office in December 2012, Shinzo Abe’s government has been determined to revive the Japanese economy. For the past 20 years, Japan’s growth has averaged only 0.8% per annum. This compares with 1.3% for Germany, 2.3% for the UK, 2.6% for the USA, 4.9% for South Korea and 10.4% for China.
The first arrow is monetary policy. The Bank of Japan has engaged in extensive quantitative easing through bond purchases in order to drive down the exchange rate (see A J-curve for Japan?), stimulate expenditure and increase the rate of inflation. A target inflation rate of 2% has been set by the Bank of Japan. Part of the problem for the Japanese economy over the years has been stagnant or falling prices. Japanese consumers have got used to waiting to spend in the hope of being able to buy at lower prices. Similarly, Japanese businesses have often delayed stock purchase. By committing to bond purchases of whatever amount is necessary to achieve the 2% inflation target, the central bank hopes to break this cycle and encourage people to buy now rather than later.
The second arrow is fiscal policy. Despite having the highest debt to GDP ratio in the developed world, Japan is embarking on a large-scale programme of infrastructure investment and other public works. The package is worth over $100bn. The expansionary fiscal policy is accompanied by a longer-term plan for fiscal consolidation as economic growth picks up. In the short term, Japan should have no difficulty in financing the higher deficit, given that most of the borrowing is internal and denominated in yen.
The third arrow is supply-side policy. On 5 June, Shinzo Abe unveiled a series of goals his government would like to achieve in order to boost capacity and productivity. These include increasing private-sector investment (both domestic and inward), infrastructure expenditure (both private and public), increasing farmland, encouraging more women to work by improving day-care facilities for children, and deregulation of both goods, capital and labour markets. The prime minister, however, did not give details of the measures that would be introduced to achieve these objectives. More details will be announced in mid-June.
