Originally published in Bloomberg Prophets column 29/1/2018. All opinions expressed are those of the author.
The Japanese tradition of naming economic expansions after Shinto deities dates back to the 1950s. A fitting name for the current period of growth, already the second longest since the war, would be the “Amaterasu boom,” referencing the sun-goddess who emerged from a long period of seclusion in a cave to bathe the land in growth-inducing light and warmth.
That is how the Japanese economy is starting to look. The long gloomy years of deflationary stagnation, sometimes known as the lost decades, appear to be ending. The turnaround started with the election of Prime Minister Shinzo Abe at the tail-end of 2012 and his appointment of Haruhiko Kuroda to a five year term as governor of the Bank of Japan in April 2013.
The chart below shows the remarkable improvement in Japan’s nominal GDP that has taken place since then.
In the Shinto myth, it took something special to lure the sun goddess outside – another goddess performing a striptease dance. Likewise, shock tactics were required to revive the Japanese economy. It was the bold program of “QE” (quantitative easing) launched by Kuroda on taking office that drove the yen down and the stock market up and told the world that big changes were afoot in Japan.
To say the policy was controversial would be an understatement. Ex-BoJ officials carped from the sidelines. The Keizai Doyukai business association was bluntly hostile. Predictions of “Abeggedon” were rife, with one well-known commentator predicting hyperinflation and default by 2018, with the yen falling to 360 to the dollar and bond yields soaring to 80%.
Other nay-sayers made more subtle points. Was QE not distorting the prices of risk assets, increasing inequality and risking another bubble? In the Japanese context at least, such criticism was wide of the mark. Even now, the Topix Index is no higher than it was thirty years ago. If there were widespread mispricings, you would expect the market to have an unusually high valuation. In fact, valuations are historically low. Much the same can be said for real estate. According to the Japan Real Estate institute, home prices in the Tokyo Metropolitan area are roughly half what they were in 1994.
Kuroda not only stuck to his guns. He also showed a willingness to experiment with new ideas. Whereas other central banks focussed their asset purchases on bonds, the Kuroda BoJ also bought equities via ETFs (Exchange Traded Funds) – and is now sitting on a handsome profit.
In early 2016, Kuroda surprised the markets again by following the Swedish example and taking policy rates negative. Despite dark rumblings from the powerful banking lobby, the lending stance of financial institutions is now at its most generous level in 27 years. Nine months later, he shifted emphasis from asset purchases to “yield curve control,” pegging the 10 year bond yield close to 0%, an approach should prove more sustainable over time.
This experimentalism was necessary because nobody really knows what is going to work. These days monetary policy is a process of trial and error. If the hyper-inflationists have been proved wrong, so have the believers in easily manipulable expectations. All over the world inflation has been coming in below central bank targets.
In Japan’s case the surprise has been that while nominal GDP has grown impressively, the split between real growth and inflation has been heavily skewed to the former. In one sense this is a success – the economy has become genuinely more productive. In terms of hitting an inflation target, though, the job is only half done. With the labour market so tight and the output gap now positive, it is likely that core inflation will creep up over the next eighteen months. Even so, the 2% target will probably remain out of reach unless something is added to the policy mix.
Any effective new approach would need to involve more active fiscal policy. The one false step that Kuroda has made in his tenure was his enthusiastic support for the 2014 hike in the consumption tax. That triggered a sudden decline in consumer confidence which has only now been fully restored.
Once more the fiscal hawks of the Ministry of Finance are agitating for a hike in the consumption tax and again it could do serious damage to animal spirits. Abe’s instincts are for fiscal expansion – via “education bonds” to fund free education and tax breaks for companies that raise wages and capital spending – but his views have little support in the financial bureaucracy.
Meanwhile, the improving economy is encouraging monetary hardliners to call for a premature exit from QE, thereby risking a damaging surge in the yen. In the Japanese context, a figure of Kuroda’s experience and credibility is required to see off the dissenters and give Abe the support he needs to run the economy hot for several more years.
Only when corporate capital investment is booming and wages are rising at 3% per year can Japan’s policy-makers relax in the assurance that the Sun Goddess is back for good.