March 14, 2011 12:37 pm

How Japan’s economy will eventually rebound

Highly distressing eyewitness reports and deeply disturbing images shed only partial light on the magnitude of the tragedy inflicted on Japan by Friday’s devastating earthquake and destructive tsunami.

Japan’s immediate focus is on the enormous human suffering, and rightly so. As people around the globe join Japan in being saddened by the loss of so many lives and in praying for the success of rescue efforts, attention also turns towards the extent of the damage to the economy and its reconstruction and rehabilitation plans.

While there is still considerable uncertainty, including on account of nuclear reactor risks, the experience of other countries suggests that the economic outlook will be dominated by five factors.

Japan’s economic growth rate will fall in the immediate aftermath of the natural disasters before rising sharply due to reconstruction activities.

Disruptions to supply chains and the loss of inventories will cause shortages and inflation to spike temporarily from very low levels.

The fiscal deficit and public debt will rise meaningfully due to lost revenues and, more importantly, emergency spending.

The central bank will ease monetary policy which, given policy interest rates floored at the zero bound, will involve the provision of extraordinary credit and liquidity facilities.

Last, the country will receive transfers from abroad, including the repatriation of funds held outside the country by Japanese residents.

Japan is a rich country that is also able to borrow at relatively low interest rates. As such, it definitely has the ability to rebound economically from these horrible natural disasters. Moreover, in a really good recovery scenario, Friday’s dreadful shock could even be a catalyst for internal political unity and for overcoming what has been two disappointing decades of economic performance. Indeed, a prolonged period of high and sustained growth is key to Japan’s handling of its domestic public dynamics.

The Japanese people are not alone in hoping for a rapid economic recovery. The rest of the world is with them. Governments and individuals in several countries are already mobilising to help Japan via large donations of equipment, money and volunteers.

This international reaction is driven by one of the noblest of all human feelings, that of empathy. Yet there is also an element of self interest. Japan is among the very largest economies in the world; it plays an important role in global trade and cross border financial flows; and its voice is influential in multilateral policy deliberations.

The world has a shared interest in the economic recovery of this systemically important country. The good health of Japan is central to a robust global economy that generates lots of jobs and enhances productivity. And, at the most basic human level, we wish for the well-being of all those in Japan who have been affected by a truly horrible tragedy.

May the heartbreaking human tragedies soon give way to many stories of miraculous rescues and the full recovery of a society that, today, is being subjected to enormous pain and disrupting uncertainties.

The writer is chief executive of Pimco

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