Well before the fear of “secular stagnation” became common across the developed world in the aftermath of the global financial crisis, Japan was unhappily showing the way. For almost two decades before the crisis, Japan recorded weak economic expansion and frequent deflation as it struggled to escape the aftermath of the 1980s property bubble.
In reality, given its low to negative population growth, Japan’s economic performance was more impressive than it seemed. Still, the country experienced the dangers of deflation, and the need to use all tools of policy to boost growth, earlier than most.
The uncertainty with which Japan learned that lesson, however, was reflected in its response to the global financial crisis, which threatened to lock the economy into permanent stagnation. The US unleashed quantitative easing as soon as 2008 and enacted fiscal stimulus in 2009. It was not until 2012, with the election of Shinzo Abe as prime minister, that Japan embarked upon a determined campaign of fiscal and monetary expansion, together with a stated aim of structural changes to increase long-term growth.
In particular, the Bank of Japan, which had already been experimenting on and off with near-zero interest rates and direct asset purchases for more than a decade, in 2013 announced a 2 per cent inflation target. It then expanded a QE programme and subsequently cut interest rates below zero to reach it.
Scepticism abounded that such stimulus would work in an oligopolistic economy struggling to raise productivity and with a relatively old population. Yet Japan is currently proving those suspicions misplaced. On Monday it was revealed that its economy expanded by an annualised 4 per cent in the second quarter, and more importantly was on course for its longest growth streak this century.
The composition of that growth was as reassuring as its rate. While Japan has traditionally been accused of relying on net exports for expansion, the quarterly change was driven by domestic demand and particularly consumption. The BoJ’s QE programme and negative interest rates did weaken the yen considerably after 2013, raising hackles among the likes of Donald Trump. But it is clear that Japanese monetary policy has worked powerfully in ways other than through the exchange rate.
Where Japan goes from here depends on whether policymakers keep their nerve. Mr Abe’s popularity has dropped sharply this year. To be fair, this mainly reflects his inept handling of a corruption scandal rather than resentment against his economic policies. Moreover, the lack of a credible challenger means Mr Abe’s position seems secure for the moment. Nonetheless, it constrains his room for manoeuvre in pushing through economic liberalisation and stimulus.
In that case, it falls to the BoJ to keep up the pressure on the economy. Fortunately, it has good reason to do so. The central bank has been forced repeatedly to push back the timing for hitting its 2 per cent inflation target. The fact that the Federal Reserve is withdrawing stimulus — perhaps, before long, to be followed by the European Central Bank — is not a reason for the BoJ to fall into line. If a widening differential in monetary policy stances further weakens the yen, so be it.
Whatever Mr Trump may think, Japan is not engaged in a campaign of deliberately undervaluing its currency. It is following an appropriate campaign of stimulus that has brought one of the world’s more troubled advanced economies out of a serious funk and back to growth. It should continue to do so.
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