Through the last six years of rumbling global financial crisis, Japan has been an afterthought. In 2008, the world’s second-largest (soon to be third-largest) economy was still dealing with the consequences of its own banking crisis from the 1990s, its economy mired in a generation of economic stagnation and low-level but persistent deflation. If you had taken a snapshot of the Japanese economy in 2002 and again in 2012, you wouldn’t have missed much.
How quickly that has changed. A new government took office the day after Christmas, led by prime minister Shinzo Abe, pledging to, in effect, go whole-hog on the Keynesian remedies for Japan’s long recession, particularly by pushing for a combination of fiscal stimulus on a mass scale, and, through appointment of Haruhiko Kuroda as governor of the Bank of Japan; he has pledged to do “whatever it takes” to get annual inflation to 2 percent in a country where inflation has averaged -0.3 percent since 2000. The Japanese stock market is on a tear and the yen has been falling steeply on currency markets, exactly the kind of reaction the BOJ hopes to see.
There is a great deal riding on their success, and not just for the 128 million residents of Japan. Because Japan has quite suddenly become perhaps the best natural experiment that economics could offer for weighing how the United States and Western Europe ought to respond to their own economic woes.
There are a series of open questions that have haunted those who argue for a more aggressive Keynesian prescription of easy money and fiscal stimulus in the United States and Europe. I’ll limit it to the two most important: Can a central bank always create higher inflation in a depressed economy, or will lots of money-printing just affect asset prices and the international value of the currency without affecting the real economy? And can public debt levels reach a “tipping point” in a large country that has its own central bank and considerable domestic demand for its bonds, which would in turn make fiscal stimulus risky when there is already high debt relative to GDP?
One of the great challenges of macroeconomics is that different countries and their economic situations are so different that it is hard to directly apply lessons from one to another. And crises in particular don’t happen all that often, so we have even fewer examples to go on as to how best to respond to them.
All the United States economy circa 2008 and Thailand circa 1998 really have in common is that both experienced some form of crisis; they are such wildly different countries economically, and their crises had such wildly different causes, that it isn’t particularly useful to judge what policies the U.S. should take on by what happened the East Asian crisis a decade earlier.
But Japan is a different story. It is a large, advanced economy, which has been grinding through the results of its own banking and financial crisis. Its story has been more one of year-after-year of stagnant growth than one of outright depression. It has control over its currency, and its citizens’ demand for government bonds is deep enough that it simultaneously has the highest debt to GDP ratio in the world and the lowest interest rates (which is quite a trick).
In effect, Japan is a cautionary tale of what the United States, Britain, and continental Europe could become if the major Western powers can’t jolt ourselves out of a long period of economic stagnation.
Shinzo Abe and Haruhiko Kuroda can’t magically make Japan’s corporate giants more competitive on the world stage, such as by making Sony competitive with Samsung in the market for smart phones or bringing back a world where Toyota could make significantly better cars that Hyundai. But their policies to depreciate the yen could give those companies a leg up in the global marketplace in terms of their cost structure that they have not had in ages; the yen has fallen from around 80 to the dollar in the runup to Abe’s Liberal Democratic party winning the elections to scraping 100 to the dollar (the exchange rate was 98.61 on Monday).
But it would be wrong to view this effort as riskless. On one hand, the efforts to return inflation could be too successful, increasing borrowing costs for the Japanese government and, in the process, making its huge debt of twice GDP exceptionally hard to maintain. On the other hand, the Bank of Japan’s easing could again prove to be not up to the task.
If everything works as planned, Japan’s industrial will return on the back of a weaker yen, an improving economy will improve its deficit picture, and the nation will soon have a goldilocks economy of prices rising about 2 percent a year and debt to GDP levels coming down. If things go awry, we could soon be staring at the mother of all sovereign debt crises. Whatever path the Japanese economy takes, it is one that will have lessons and implications for all of us.