Staying the course of Abenomics

The S&P's Chief Global Economist

Yesterday I listened to Paul Sheard, Chief Global Economist and Head of Global Economics and Research for Standard & Poor’s Rating Services comment on the progress of Abenomics thus far. He was speaking at a professional luncheon at the Foreign Correspondents Club of Japan.

Sheard has a long working relationship with Japan, having previously worked as Global Chief Economist and Head of Economic Research at Nomura Securities, a position he earlier held at Lehman Brothers, where he was also Lehman’s Asia Chief Economist.

Sheard framed Abenomics not as 3 arrows but rather as two policy pillars, one pillar aggressive monetary policy coordinated with fiscal policy and the other pillar supply-side structural reform to spur economic growth. Sheard considered Abenomics as “conventional” in concept of orthodox economics but in a Japanese context a sharp break from previous BOJ policy.

He referenced economic statistics that are striking to describe Japan’s two-decade battle with deflation. From an all-time high of 112.70 Index Points in the 4th quarter of 1994, Japan’s GDP deflator fell to a record low of 89.60 in the 1st quarter of 2013, before increasing to 92.70 in the 4th quarter. Since its peak in the 4th quarter of 1997, Japan’s nominal GDP has been -8%, compared with an increase in nominal GDP of 96% in the US. Four factors severely aggravated Japan economic results: the 2008 financial crisis, Fukushima disaster, yen strengthening to 75, and Eurozone debt crisis.

Regarding the first policy pillar (or 1st and 2nd arrows) of Abenomics, Sheard gave the Abe government (including the Kuroda-led BOJ) good marks.  He considered Kuroda’s policy shift a revolutionary shift in thinking, with the resolute message of “Yes, we can, yes we will” end deflation.

Is Abenomics working? The reflation objective is going well, with nominal GDP growth spurred by public investment up 18%. Public sentiment is good. But victory is not yet secure. The BOJ is on the right track but the handicap of deflation, so long embedded in the economic fabric, is not easy to overcome. And there is not yet strong evidence that Japan corporates are convinced of the enduring benefit of Abenomics.

Regarding the second policy pillar (or 3rd arrow), results so far are less impressive. Growth can come from 3 sources: increased labor, increased capital, and increased productivity though innovation and greater efficiency. With Japan’s population projected to decrease from 128 million in 2010 to 100 million by 2048 and 68 million by 2060 (fertility rate of 1.41 (2012) vs. 2.07 needed to maintain the population steady), Abe must increase the labor participation rate through measures designed to increase female workers and enlightened immigration policy, a holistic approach.

Sheard was firm in his belief that the Abe government should stay the course on monetary policy, even doubling down on monetary expansion. He steered away from making quarterly forecasts of GDP, indicating that S&P emphasizes a longer-term view, but did recognize both a widely expected strong 1st quarter result and a downturn in the 2nd quarter influenced by the impact of the consumer tax increase. Just released: Japan’s 1st quarter GDP rose 5.9%, the best showing in 2 1/2 years.

Staying the course is Japan’s best bet for ending deflation and achieving economic growth.  Abe has an unusual window of opportunity—the turnover of prime ministers in recent Japanese history is frightening (8 in the 21st century). We should give him an ample chance to prove that his policy works.

All the best,

Warren J. Devalier

©2014 Warren J. Devalier