Is Japan set to lead after 20 years of torpor?
As 2012 draws to a conclusion, it’s likely that the fiscal cliff will be averted, U.S. politics and monetary policy are irrevocably set, European politics are suspended until September’s German election and the Chinese leadership transition is over. In short, the political and monetary uncertainties that have obsessed financial markets and paralyzed business have all been dispelled. As a result, 2013 promises to be a year for businesses and investors to focus again on economic fundamentals and corporate performance instead of delaying decisions while they waited with bated breath for the next euro summit, or election, or meeting of the Federal Reserve and European Central Bank. In one part of the world, however, events are moving the other way.
In Japan, economic and business conditions remain as dull as ever, but politics and monetary policy are suddenly exciting. And while the world has largely lost interest in Japan, the gestalt shift in the world’s third-largest economy could have big implications for global business and for the way voters think about governments and central banks.
Last weekend’s landslide election of Shinzo Abe, a potentially powerful prime minister, was largely a result of his promise of a revolution in monetary policy designed to jolt the Japanese economy out of its 20-year stupor. If Abe delivers on his election rhetoric – still a big “if”, especially in a country where power is wielded mainly by bureaucrats rather than elected politicians – the global impact could be huge.
At a practical level, Abe has promised to force the Bank of Japan to print money and weaken the yen until Japan’s inflation rate accelerates to 2 percent and growth is restored. If he acts on this promise, the effect will be to strengthen the dollar, not only against the yen but also against the euro and other major currencies. If the yen weakens substantially, high-end exporters in Germany and the rest of Europe will stop gaining market share from Japanese rivals to offset their loss of competitiveness in the U.S. market. The same will be true for Korean and Chinese exporters, which have been crushing Japanese competitors hobbled by the strong yen.
Less obvious, but even more important, could be Japan’s impact on the global debate about macroeconomic management. The era when monetary policy was simply about controlling inflation is over. The consensus on macroeconomics created by the Reagan-Thatcher political revolution and the near-simultaneous monetarist revolution in economic thinking has broken down.
The singular focus on inflation made sense in the 1980s, when rapidly rising prices were the biggest problem facing most economies. Politicians, led by Ronald Reagan and Margaret Thatcher, realized that the only sure way to stop inflation was to create previously unthinkable levels of unemployment by relentlessly raising interest rates. Since nobody wanted to take political responsibility for firing workers, economists had strong incentives to come up with theories that proved unemployment was natural and inevitable, that macroeconomic policy could do nothing about it and that the sole effect of monetary policy was on inflation. A natural and convenient corollary was to absolve governments of responsibility for monetary management and shift this to politically independent central banks.
Since economists understand incentives, it was not long before they unanimously embraced the three key policy implications of the 1980s monetarist revolution: acceptance of a “natural” rate of unemployment, exclusive reliance on inflation targeting and political independence for central banks.
Any economist or political analyst who suggested anything different – for example, that politicians should coordinate monetary and fiscal policy to manage unemployment, as well as inflation – was laughed out of university economics departments, as well as finance ministries and central banks. This purge is now over.
In the past few weeks, central bankers have broken the taboo against acknowledging any responsibility for unemployment. Federal Reserve Chairman Ben Bernanke has committed the Fed to a 6.5 percent unemployment target and Mark Carney, the governor of the Bank of Canada and soon of the Bank of England, has proposed targeting the growth of gross domestic product. These were earth-shattering events for economists who have spent the past 30 years training themselves and their students to deny that monetary policy could have any lasting effects on unemployment or economic growth.
But while a revolution is under way in the attitude to economic targets, the new tools and instruments required to hit these targets have hardly begun to be discussed. The unemployment and GDP targets suggested by Bernanke and Carney are empty promises in the absence of policy tools that could convincingly boost jobs and growth in the present deflationary environment. Which is where Japan comes in.
No other economy has (yet) suffered anything like Japan’s 20 years of economic stagnation. It would not be surprising, therefore, if truly radical measures to deal with deflation were pioneered in Japan. Outside Japan, no central banker or politician has yet gone beyond pumping money into bond markets through quantitative easing. And nobody has suggested, at least officially, that central banks should directly lend to governments or finance one-off tax cuts.
These truly radical policies, which amount to handing out newly created money to businesses and households, are sometimes described as “helicopter money” or “quantitative easing for the people.”
Such policies would be certain to pull the world out of deflation, but public discussion of such policies remains impossible in the U.S. and Europe because they break the last remaining monetarist taboos: monetary financing of government spending or tax cuts, and the political independence of central banks. These two forbidden options – ending central bank independence and then ordering the BoJ to print money for infrastructure spending or tax cuts – have now taken center stage in Japan.
By breaking the taboos created by the monetarist revolution of the 1970s, Japan could accelerate and reinforce the revolution in economic thinking that started in 2008. After 20 years of Japanese torpor, could the world be transformed again by ideas “Made in Japan”?