BAD AS IT has been, the global economic crisis that began five years ago could have been a lot worse if major countries had responded with protectionist tariffs or deliberate export-boosting currency devaluations. Instead, there’s been little back-sliding on free trade, and the United States and Europe have begun talks to make it freer.
To be sure, the central banks of the United States, Europe and Britain massively expanded their balance sheets to support domestic growth. Lower exchange rates were a side effect of this money-printing — causing export-dependent developing nations to complain about a “currency war.” But for the most part, that threat hasn’t materialized, in part because salvaging U.S., British and European growth enabled them to continue importing from developing countries.
There’s renewed fear of a currency war now that Japan, the sole major industrialized democracy to expand its central bank balance sheet in the crisis, has decided to get into the game. Newly elected Prime Minister Shinzo Abe is pursuing the explicit goal of ending two decades of deflation. Expecting this to produce a cheaper yen, markets have driven the Japanese currency down 20 percent against the dollar since October.
But economists widely agree that Japan needs monetary stimulus and the cheaper yen need not threaten the global economy — as long as it happens as a byproduct of domestic monetary expansion and not overt government intervention on foreign exchange markets. That is a line that major industrial democracies have not crossed, for fear of triggering retaliation by others, especially China — which has actually slowed its notorious currency manipulation in recent months, quietly allowing the yuan to appreciate, to the benefit of the United States among others.
A statement last week by the Group of 20 industrial countries and leading emerging markets — “we will refrain from competitive devaluation” — amounted to a green light for Mr. Abe’s new economic approach and an implicit warning not to devalue Japan’s currency directly by buying foreign bonds. Of course, Mr. Abe still hasn’t ruled out direct intervention, but, in a hopeful sign, he told Japan’s parliament after the G-20’s statement that the need for foreign bond-buying “has considerably declined” because of the yen’s fall to date.
Like monetary expansion in the United States and elsewhere, looser central bank policy in Japan may be necessary but not sufficient to restore robust growth. Structural reform of its maxed-out export-led growth model is what Japan needs above all, and to his credit Mr. Abe has labeled that the “third arrow” in a policy quiver that includes monetary and fiscal expansion. Yet reform is also the hardest policy to carry out, given the many interest groups wedded to the status quo.
Among the measures that those groups dislike is one that would do the most to modernize Japan’s protected, inefficient domestic markets: full participation in the Trans-Pacific Partnership (TPP), a regional free-trade initiative spearheaded by the United States. Mr. Abe is set to discuss the TPP with President Obama on Friday during a visit to Washington. For the sake of their respective economies, and the global system, Mr. Obama should do everything he can to help this ally help itself.