Japan is in the process of becoming the first important developed economy
to overtly subvert the independence of the central bank.
By PINCHAS LANDAU
Not acquainted with that term? Not to worry – all sorts of new-fangled concepts vaguely connected with economics come and go in the crowded public arena, and this is certainly a pretty recent addition.The “Abe” part of the term is none other than Shinzo Abe, the new prime minister of Japan, who regained this office, which he occupied in 2007, following the crushing victory of his Liberal Democratic Party (LDP) in the general election on December 16 over the Democratic Party of Japan (DPJ). The DPJ had wrested power from the LDP in 2009, in what was then considered a major upset in Japanese politics, since the LDP had ruled almost uninterruptedly since the 1950s.But the return of Abe and the LDP has ushered in a new approach to economic policy and a seemingly determined effort on the part of the new/old prime minister and his veteran party to drag Japan out of its prolonged slump. The former economic powerhouse and envy of the world has been sinking, seemingly helplessly, into a deflationary spiral for the better part of 20 years. The list of Japan’s problems is fearsomely long, beginning with the demographic disaster that the nation is inflicting on itself, and ending perhaps with the political paralysis that is deeply entrenched in Tokyo and has prevented any and all attempts to change the nation’s terminal trajectory.A mere 58 years old – a stripling by the standards of Japan’s geriatric politicians – Abe has convinced the Japanese people that he really can change things, starting with himself and his party. His previous spell as premier was described, charitably, by the Economist magazine as “a shambles,” but he says he has learned the lessons from that failure.One key lesson seems to be that to defeat deflation, you have to conjure up inflation, and that to do that, you have to print a lot of money – and to do that, you have to control the central bank. Japan is therefore in the process of becoming the first important developed economy to overtly subvert the independence of the central bank. Fortunately for Abe, the present governor’s term expires this April, allowing him the opportunity to appoint not just the new governor, but his two deputies as well.Throughout his election campaign, Abe hammered away at the theme that the central bank was not doing enough to halt deflation and create some inflation. Now he is going to “persuade” the central bank to adopt a formal inflation target of 2 percent per annum. It is already clear that the Bank of Japan is going to not just announce that target, but actively seek to reach it. This will require even larger-scale purchases of government bonds by the central bank than it has been making in recent years – which is perhaps just as well, since, on the fiscal side, the new government is launching (yet another) round of extra spending on public works, and these will be financed by yet more government borrowing.This fiscal policy is neither new nor attractive. Indeed, it is hard to see how it will spark an economic revival, since this strategy has failed to do so hitherto. One of many jawdropping facts about the Japanese economy is that the government budget has, for the last six years, seen less than half its mandated spending covered by tax revenues, with the “remainder,” – i.e., more than half – financed by borrowing.AdvertisementThe result is that Japan has by far the highest debt-to- GDP ratio of any developed economy – yet the government bond market offers even lower nominal yields than the US or Germany, thanks to the chronic deflation, which makes a 1% per annum yield worth 2% or even 3% in real terms.If, somehow, the government was to achieve its wish of generating a 2% inflation rate, government bond yields would soar and bond prices would sink, likely generating a financial panic.In practice, however, the bond market has hardly reacted to the change of government and to the heated inflationary rhetoric. This is in sharp contrast to the other financial markets: Abe’s pre-announced program to force the value of the yen lower, as part of the pro-inflation drive and with a view to spurring economic activity, caused the Japanese currency to start falling even before he took office; this week, the yen neared 90 to the dollar, a drop of almost 20% from its recent peak of 76. In tandem, Tokyo’s stock market has soared, as a weaker yen is expected to help Japan’s hard-pressed exporters to regain their profitability.All this is a prelude to the substantive solutions to Japan’s deep-seated problems, which can be achieved only by fundamental reforms – of the sort most recent governments have refused to contemplate. Abe says he can and will deliver them, and the currency and stock markets seem to believe him, although the bond market clearly doesn’t.Given Japan’s weight in the global economy and financial system, whether he succeeds or not will have a direct impact on everyone, so it is worthwhile keeping track of Abe and his email@example.com
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