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THE TRUTH ABOUT ABENOMICS - The

Japanese Economic Experiment That's


Captivating The World

https://www.businessinsider.in/the-truth-about-abenomics-the-japanese-
economic-experiment-thats-captivating-the-world/articleshow/
21249656.cms

There's a new government in Japan, and it appears determined to finally do "whatever it


takes" to attempt to revive the moribund Japanese economy, which has struggled with
deflation for a decade. The plan – called "Abenomics," named after newly-elected Prime
Minister Shinzo Abe – is three-fold. It involves a massive increase in fiscal stimulus through
government spending, a massive increase in monetary stimulus through unconventional
central bank policy, and a reform program aimed at making structural improvements to the
Japanese economy.

In short, "Abenomics" amounts to one of the biggest economics experiments the modern
world has ever seen. Financial markets are loving it. The Japanese stock market is soaring.
But what exactly is it, and how is it expected to work? In a recent report, titled "Abenomics
Handbook," Nomura economists led by Tomo Kinoshita break down the Japanese
government's new plan and examine the challenges facing it.

Naturally, the first question is: How exactly are these policies supposed to boost the
economy? While fiscal stimulus and structural reform are essential components of the
experiment, monetary policy is expected to do most of the heavy lifting in the short term. So,
let's take a look at the monetary policy behind the plan first.

The monetary policy aspect of Abenomics

The goal of easy monetary policy is to reduce real interest rates. In Japan's case, it has a
significant side effect of weakening the yen. So, the yen is weakening – and it's beginning its
journey downward from incredibly elevated levels. (In recent years, investors piled into yen
as a safe-haven currency, helping to drive up its value.)
Business Insider / Matthew Boesler, data from Bloomberg

A weaker yen could be virtuous for the Japanese economy. The currency has already
devalued swiftly against the dollar since September, when the wheels of a new economic
regime in Japan were set in motion.
This does a number of things. Most importantly, it boosts exports, because other currencies
can now buy more Japanese-manufactured products. That means manufacturers are selling
more, which feeds into corporate earnings and hopefully translates to increased business
investment.
All of this should boost stock prices on a fundamental basis. At the same time, the weakening
yen provides fuel for stocks. Since September, the Japanese government has verbally "talked
down" the yen, and a big rally in the Nikkei materialized along with the decline of the
currency.

"As for the specific effect of higher share prices on the economy," the Nomura team writes,
"we think higher share prices invigorate corporate capex by (1) making it easier for
companies to raise funds, and (2) making companies more likely to invest in business
expansion. We estimate that a 10 percent rise in share prices boosts capex by 3.2 percentage
points one year later."
And the wealth effect is a big part of the plan.
Matthew Boesler / Business Insider, data from Bloomberg
"For households, we think higher share prices stimulate willingness to spend by boosting the
value of shareholdings and giving an indication of the health of the economy," the Nomura
economists continue. "We estimate that a 10 percent rise in share prices boosts consumer
spending by 0.12 percentage points three months later." All of this works to narrow the ¥16.5
trillion (~ $170 billion) gap between current GDP and potential GDP, thus working toward
eliminating deflationary pressures. However, the Japanese government has come under fire in
the international community recently for its verbal interventions in the yen that have caused it
to swiftly devalue against other currencies.

The Bank of Japan has a few other options. Recently, it announced that it would double its
target inflation rate to 2 percent, employing open-ended asset purchases (much like the
Federal Reserve is doing in the United States) to get there. This represents a shift from the
conservatism that has characterized the Bank of Japan in recent years. Haruhiko Kuroda, a
big dove on monetary policy (meaning he's usually in favor of more stimulus, not less), is set
to take over at the helm of the central bank in April. The times are changing, and one can
expect to see some experimentation in the months and years ahead.

The Abenomics approach to fiscal policy

The second part of the "Abenomics" game plan involves short-term fiscal stimulus. This aims
to revive economic growth immediately through increased government consumption and
public works investment.
Abe already introduced ¥5.3 trillion (~ $60 billion) in public works spending as part of its
2013 budget. That's up from an estimated ¥5 trillion (~ $50 billion) last year, according to
Nomura, representing a change from the fiscal tightening that Japan has undergone in recent
years.
"?Aside from the general account, the government plans to set aside spending for post-quake
reconstruction efforts in special accounts," says Nomura. "The Abe government has decided
to boost total spending on the five-year effort (through FY15) to about ¥25 trillion (~ $260
billion), from ¥19 trillion (~ $200 billion) previously."
The important point here is that the government is pledging to be flexible with regard to fiscal
policy in the coming years, a stance in stark contrast to those in the United States (which is
dealing with the effects of sequestration) and the euro area (where economic austerity is
helping to deepen the economic contraction there).

Structural reforms – the most important aspect of Abenomics

Loose fiscal and monetary policy is supposed to facilitate expansionary economic conditions
in the short term (although weakening the yen is arguably a longer-term goal as well).
Crucially, though, the success of "Abenomics" hinges on the third prong of the approach:
structural reform. The Nomura economists call this "the key to improving medium-term
growth potential," details of which are expected to be unveiled to the public in June.
"With government debt having expanded to more than 200 percent of GDP, we think it will
be difficult for Japan to boost the economy in the medium term via fiscal spending alone,"
they write. "As the effects of bold monetary easing are primarily transmitted via expectations
on the financial and capital markets, any resultant move out of deflation is likely to be short
lived unless economic growth can also be boosted via the government's growth strategy."
Below is a summary of the growth strategy currently under proposal.
Nomura, based on Headquarters for Japan's Economic Revitalization data
There are several aspects to the regulatory reforms under proposal as well, outlined below.

Nomura, based on regulatory reform panel (within Cabinet Office) data

In short, there is a lot of work to do. Will the Abe government be able to get it all done?
There are some serious open questions about its ability to achieve success in putting the
Japanese economy back on stronger footing.

Why Abenomics might not work


The first question is whether the Bank of Japan will be able to implement monetary policy to
actually effect 2 percent inflation. After all, they've been operating with a 1 percent inflation
target, and they haven't even been able to come close to that.

The Nomura economists write, "While we think attainment of the 2 percent inflation target
will be problematic, we see the establishment of the 2 percent inflation target as meaningful
because setting the bar high and bringing on board more powerful easing measures makes an
end to deflation more likely."
Nomura also acknowledges the risks to financial stability that may arise from excessive
monetary easing, warning that "if the BOJ were to sharply increase its purchases of financial
assets, this could cause distortions in the markets for those financial assets, disrupting
market mechanisms or producing unforeseen risks related to the accumulation of imbalances.
In other words, there could be bubble trouble.
The Abe government's fiscal approach is tricky, too. Good policy strives to be counter-
cyclical, meaning that when the economy improves, the government should take the
opportunity to tighten its belt.

There's a consumption tax hike scheduled for 2014, though. Nomura thinks the Abe
government will boost spending to offset it.

"The biggest challenge," the economists say, "is striking a balance with fiscal reconstruction."
Abe's government says it wants to cut the budget deficit in half from 2010 levels by 2015 and
flip the budget balance into outright surplus by 2020. Continued public spending could make
that pretty difficult.
Finally, if the yen stops weakening, it really puts the brakes on the entire "Abenomics"
project. The yen is expected to continue its decline – and many expect the U.S. dollar to enter
a new bull market – but, as ever, the future is uncertain, and for Japan, it depends on
implementation.
We should also note that this all assumes that the Abe government is committed to the task to
begin with. There is at least one theory that ultimately calls this commitment into question.
(Everybody Is Talking About The Japanese Yen's Collapse, But Nobody Understands The
Prime Minister's True Motivations.)

The Nomura economists come to the following conclusion: Yen depreciation benefits
exporters but it could also have an adverse effect on the economy via an expansion of the
trade deficit or a deterioration in the terms of trade (export prices/import prices). Also, the
benefits of fiscal expansion and monetary easing are not limitless. In particular, fiscal and
monetary easing are not limitless. In particular, fiscal expansion could stimulate market
concerns regarding problems securing funding and fiscal risk.
For Japan's economy to overcome these challenges and be revived, we think the key
requirements are a change in ingrained expectations about deflation (ie, an improvement in
growth expectations), a self-sustaining increase in private-sector economic activity (ie,
growth without fiscal expansion), and fiscal reconstruction (ie easing of fiscal risk). If
companies can pass higher import prices and other cost increases onto selling prices, we think
restructuring pressures in Japan will lessen. If confidence in economic growth in Japan grows
simultaneously with an improvement in Japan grows simultaneously with an improvement in
corporate earnings, we think increases in employment and wages will be likely.

If real wages increase amid efforts to end deflation and put inflation on track, we think the
Japanese economy will be more likely to return to self-sustaining growth. The rest of the
world will be watching closely.

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