When Shinzo Abe became prime minister after the December 2012 snapback election that brought his party, Japan’s Liberal Democratic Party (LDP), back into power, he promised to “…implement bold monetary policy, flexible fiscal policy and a growth strategy that encourages private investment.”  These three policies eventually formed the “three arrows” of what became known as “Abenomics,” Abe’s radical plan that promised to accomplish something that had eluded Japan for two decades: an end to chronic deflation and the creation of self-sustaining growth. Popular with the public and armed with a supermajority in the parliament, Abe had the support to implement monetary and fiscal stimuli, the first two arrows of “Abenomics,” in 2013. As part of Abe’s plan, Japan’s central bank, the Bank of Japan (BOJ), launched a massive stimulus spending campaign and its governor, Haruhiko Kuroda, pledged to do “whatever it takes” to reach the inflation target of 2% within two years. Within a month of becoming prime minister, Mr. Abe also introduced a plan for 10.3 trillion yen ($117 billion) in fiscal stimulus through increased government spending. The quick succession of bold actions drew international attention, placing Japan back into the spotlight as the world watched to see if Mr. Abe’s economic experiment would reinvigorate the world’s third largest economy or send it deeper into crushing debt.

By the end of 2013, with two of the three Abenomics arrows fired, Abenomics appeared to have succeeded in propping up the Japanese economy. However one year later, with the release of official third quarter 2014 data on November 17th, the numbers show that the Japanese economy is back in a technical recession, its fourth since 2008. In a devastating turnaround from 2013, inflation is stagnating well-short of the 2% target set by the BOJ despite efforts to rapidly expand Japan’s monetary base through huge infusions of stimulus spending and private consumption remains weak. With domestic support for Abe and Abenomics deteriorating, the future of Abenomics after 2014 is uncertain.

The Source of the Problem

Many have taken the disappointing third quarter figures as indicators that Abenomics is failing, and while it is true that Abenomics is falling short of its lofty expectations, the roots of Japan’s economic woes in 2014 stem from a separate entity: the government’s increase of the consumption tax.

The consumption tax hike, the first in 17 years, was to double the tax from 5% to 10% over two stages of tax increases. The government implemented the first stage of the tax increase, which increased the tax from 5% to 8%, at the start of the second quarter in 2014. However, while the unpopular tax hike was implemented under Abe, it was actually planned under Abe’s predecessor Yoshihiko Noda of the Democratic Party of Japan (DPJ).

The last of a series of three prime ministers from the DPJ, Noda saw the public support for his party evaporate under his term as the Japanese economy descended into its third recession in five years. Nevertheless, Noda was determined to pass his unpopular tax bill, which he believed was necessary in order to control Japan’s massive debt and enforce much-needed fiscal responsibility. Unable to gather enough support from within his own fractured party to ensure the bill’s passage, Noda reached out to Abe and the LDP. By promising to dissolve the lower house of the parliament to call for early elections in return for support of the bill’s passage, Noda effectively traded his political career and the political power held by his party for the passage of the tax bill, a trade Abe and the LDP were more than willing to make.

Departing from Abenomics: A (Premature) Call for Fiscal Responsibility

After winning the December 2012 election in a landslide, Abe and the LDP set to work in implementing the early stages of Abenomics. Through October 2013, the world watched as the Nikkei rose 40%, inflation rates increased on target along with private consumption, and the Japanese economy logged over 3% (up from 1.4% in 2012) growth for the first two quarters. Encouraged by the positive numbers and confident in his programs, Abe, in his own “Mission Accomplished” moment, announced “Japan is back,” a claim now proven premature.

With the success of Abenomics seemingly imminent to some, calls for fiscal austerity and fiscal responsibility gained traction by the end of 2013. With a debt of over 240% of its GDP and an annual deficit of about 8%, Japan has the dubious distinction of having the highest proportion of debt to GDP in the developed world. Under advice from the International Monetary Fund (IMF) and seeing the positive numbers as evidence of an “economic upturn,” Mr. Abe decided in October to go ahead with the first stage of the consumption tax increase from 5% to 8% scheduled for April 2014 under Noda’s original bill.

The previous consumption tax increase in 1997 from 3% to 5% had pushed Japan from economic recovery into a recession, and in the fall 2013 issue of The Financier, the authors of the article “Abenomics: Death by Taxes” expressed concerns that the Japanese economy would repeat that past trajectory and fall back into recession. While there were concerns at the time that the new tax would create a similar effect as the 1997 tax hike, most expected that the added stimulus implemented by the government to accompany the tax hike in addition to the positive effects of the ongoing fiscal and monetary stimuli would be enough to largely offset the shock of the 3% increase in the consumption tax. While some analysts remained skeptical, most projected that the effects would be mainly contained within one quarter and projected overall positive economic growth of about 1.7% for 2014. Even the most bearish estimates failed to predict the Japanese economy’s 1.6% contraction in the third quarter, a quarter that was supposed to show signs of recovery from the effects of the tax hike that caused Japan’s real GDP to fall 7.3%. Even the catastrophic 1997 tax increase, which sent the Japanese economy into an 18 month recession and led to the resignation of then PM Ryutaro Hashimoto, only produced an initial 3.8% drop in GDP, which rebounded to a 1.7% growth in GDP in the next quarter. In comparison, the third quarter figures are alarming, and knowing the consequences that followed the 1997 tax increase, the next few months will be a critical period for Abe and Abenomics.

In light of these disappointing numbers and the purported role of April’s tax increase in causing them, Abe has postponed the second planned tax hike, originally scheduled for October 2015, 18 months while he focuses on stimulating economic growth and reaching the 2% inflation target. For a program like Abenomics to work, it needs to create confidence through consistency. In many ways, by prematurely pushing forward the tax hike before the Japanese economy was sufficiently primed for the blow, Abe effectively took a step backwards from the “whatever it takes” mentality that characterized Abenomics. As a result, Abe both impeded the progress of his own program and decreased the overall confidence in Abenomics. In order to gain the confidence of the Japanese people, the Japanese government must operate with the realization that the government’s growing debt, while a serious problem, comes second to ensuring Japan’s economic recovery.

A Return to Abenomics: Kuroda and the BOJ

With the second tax hike postponed indefinitely, Abe can redouble his efforts to revive the Japanese economy through Abenomics, and the BOJ and its governor Haruhiko Kuroda, who was appointed to the position by Abe, are instrumental to Abe’s plans.

Currently, the BOJ under Kuroda has engaged in an aggressive monetary stimulus program through a series of massive bond purchases on the scale of 60-70 trillion yen ($527-615 billion) annually, which would have doubled the monetary base in a two year period. In a surprise announcement on October 31st, Mr. Kuroda announced that the BOJ would increase bond purchases to 80 trillion yen ($703 billion) annually in order to fight deflation. The news sent stocks skyrocketing up to seven year highs and sent the yen to its steepest five day drop in nearly twenty years. The BOJ’s quantitative and qualitative easing (QQE) program has contributed to the weakening of the yen, which has fallen from 87 yen per dollar to 117 against the dollar since Mr. Abe began his term as prime minister and has staved off deflation.

The BOJ’s QQE program has increased profits for Japanese exporters, who are reaping the benefits from the more favorable exchange rates and has increased profits for investors after a year that has produced record stock market levels. However, the additional monetary stimulus announced in October, when paired with the disappointing third quarter economic figures, show that Abe’s second arrow is not quite making the mark it was expected to. Furthermore, the 2% inflation by 2015 goal, an important cornerstone of Abenomics, has been adjusted so that the time has become more open-ended as it becomes increasingly obvious that the 2015 deadline will not be met. In addition to this revision, Kuroda’s ability to continue the BOJ’s aggressive monetary stimulus is another source of worry. In the vote for the October stimulus, the BOJ’s nine-member board barely passed the stimulus spending with a five-to-four split among the members due to concerns over the accumulating costs of QQE.

Japan’s Deflationary Mindset

Given the success of the BOJ’s QQE program in raising stock prices and stimulating exports, it may seem surprising that these successes have not translated into increased consumer confidence. The inflation generated by the BOJ’s policies was intended to force the Japanese to increase consumption instead of stowing away their earnings. However, weak domestic demand persisted into the third quarter as consumers chose to forgo big-ticket items such as houses and cars following the tax hike, and the BOJ’s QQE program is partially to blame. While the weaker yen resulting from the BOJ’s monetary stimulus program is benefitting exporters, it has hurt domestic consumers by making imports more expensive. For a country as resource-poor as Japan, the increase in import prices has hit the Japanese people particularly hard, and while companies and rich individuals are making enormous profits from the effects brought about by Abenomics, these windfalls have not been distributed back to the majority of the Japanese in the form of increased wages. Real wages have fallen, and with companies sitting on their profits, Japanese consumers have also retained their “deflationary mindset” and have not increased their consumption to expected levels. Worse still, the perception that Abenomics is a program that primarily benefits the wealthy is hurting public support for Mr. Abe’s policies. Although Mr. Kuroda has encouraged businesses to raise wages and spend assuming a 2% inflation rate, the deflationary mindset of the Japanese, a mindset that has understandably been deeply ingrained after nearly two decades of the economy cycling through bouts of recession and short recoveries, must be combated for Abenomics to reach its full potential.

The Third Arrow and Moving Forward

Of course, while monetary stimulus by the BOJ and fiscal stimulus by the government are both important components of Abenomics, only the implementation of structural reforms to address the inefficiencies and distortions of the Japanese economy will lead to long-term self-sustaining growth. Never completely fleshed out by Mr. Abe, the third arrow of Abenomics is to consist of the deregulation of markets and the inclusion of women into the workforce, among other reforms. With Abe’s waning popularity and the general reticence of Japanese unions change their ways, the third arrow will be challenging to implement.

Additionally, while Abenomics has become the calling card for Mr. Abe, two of his other policies, collective self-defense and nuclear power, should also be carefully considered in relation to the Japanese economy. A nationalist, Abe’s views have, on several instances, offended China and Korea, which has been detrimental for trade between Japan and two of its most important trading partners. Separately, Abe’s eagerness to reemploy nuclear power production, which was halted after the 2011 Fukushima disaster, while unpopular, could be the answer to alleviating Japan’s growing energy costs.

“Whatever it Takes”

The greatest immediate obstacle that Abe and the Japanese government must face is the populace’s lack of confidence in Abenomics, a lack of confidence that will not be helped by inconsistencies in government policy. Overall, the third-quarter figures, while dismal, will hopefully serve as motivation for the Japanese government to recommit to Abenomics in order to promote economic recovery. By recommitting to the spirit of “whatever it takes,” the light at the end of the tunnel for Japan may just be around the bend.


Written by thefinancier

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